UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
| þ | Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the quarterly period ended September 30, 2004
| o | Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. |
For the transition period from to
Commission File Number 0-24429
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
| Delaware | 13-3728359 | |
| (State or Other Jurisdiction of Incorporation or Organization) |
(I.R.S. Employer Identification No.) |
|
| 500 Glenpointe Centre West, Teaneck, New Jersey | 07666 | |
| (Address of Principal Executive Offices) | (Zip Code) |
Registrant’s telephone number, including area code
|
(201) 801-0233 | |
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: þ | No: o |
Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act.)
| Yes: þ | No: o |
Indicate the number of shares outstanding of each of the Registrant’s classes of common stock, as of November 1, 2004:
| Class |
Number of Shares |
|
| Class A Common Stock, par value $.01 per share | 132,963,380 |
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
TABLE OF CONTENTS
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
(Unaudited)
(in thousands, except per share data)
| Three Months Ended | Nine Months Ended | |||||||||||||||
| September 30, |
September 30, |
|||||||||||||||
| 2004 |
2003 |
2004 |
2003 |
|||||||||||||
Revenues |
$ | 155,429 | $ | 98,111 | $ | 413,892 | $ | 257,498 | ||||||||
Revenues — related party |
— | — | — | 2,575 | ||||||||||||
Total revenues |
155,429 | 98,111 | 413,892 | 260,073 | ||||||||||||
Cost of revenues |
84,585 | 52,968 | 225,153 | 141,126 | ||||||||||||
Gross profit |
70,844 | 45,143 | 188,739 | 118,947 | ||||||||||||
Selling, general and administrative
expenses |
35,889 | 22,861 | 94,614 | 59,624 | ||||||||||||
Depreciation and amortization expense |
4,083 | 3,008 | 11,776 | 8,397 | ||||||||||||
Income from operations |
30,872 | 19,274 | 82,349 | 50,926 | ||||||||||||
Other income (expense): |
||||||||||||||||
Interest income |
1,267 | 617 | 2,922 | 1,358 | ||||||||||||
Other income (expense) — net |
(252 | ) | (21 | ) | (31 | ) | (120 | ) | ||||||||
Split-off costs (See Note 2) |
— | — | — | (2,010 | ) | |||||||||||
Total other income (expense) |
1,015 | 596 | 2,891 | (772 | ) | |||||||||||
Income before provision for income taxes |
31,887 | 19,870 | 85,240 | 50,154 | ||||||||||||
Provision for income taxes |
(5,835 | ) | (3,910 | ) | (15,599 | ) | (10,514 | ) | ||||||||
Net income |
$ | 26,052 | $ | 15,960 | $ | 69,641 | $ | 39,640 | ||||||||
Basic earnings per share(1) |
$ | 0.20 | $ | 0.13 | $ | 0.53 | $ | 0.32 | ||||||||
Diluted earnings per share(1) |
$ | 0.18 | $ | 0.12 | $ | 0.49 | $ | 0.30 | ||||||||
Weighted average number of common
shares outstanding — Basic(1) |
131,747 | 125,803 | 130,248 | 124,063 | ||||||||||||
Dilutive effect of shares issuable as
of period-end under stock option
plans(1) |
10,974 | 12,361 | 11,597 | 10,149 | ||||||||||||
Weighted average number of common
shares outstanding — Diluted(1) |
142,721 | 138,164 | 141,845 | 134,212 | ||||||||||||
Comprehensive income: |
||||||||||||||||
Net income |
$ | 26,052 | $ | 15,960 | $ | 69,641 | $ | 39,640 | ||||||||
Foreign currency translation adjustments |
(128 | ) | 292 | 177 | 422 | |||||||||||
Comprehensive income |
$ | 25,924 | $ | 16,252 | $ | 69,818 | $ | 40,062 | ||||||||
| (1) | Reflects a 2-for-1 stock split effected by a 100% stock dividend paid on June 17, 2004 (See Note 1). |
The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.
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COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
(Unaudited)
(in thousands, except par values)
| September 30, | December 31, | |||||||
| 2004 |
2003 |
|||||||
Assets |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 250,370 | $ | 194,221 | ||||
Investment in short-term bank deposits |
20,021 | — | ||||||
Trade accounts receivable, net of allowance of $1,261 and $989,
respectively |
86,781 | 52,253 | ||||||
Unbilled accounts receivable |
16,952 | 9,543 | ||||||
Current tax asset |
23,609 | 14,066 | ||||||
Other current assets |
14,271 | 8,414 | ||||||
Total current assets |
412,004 | 278,497 | ||||||
Property and equipment, net of accumulated depreciation of $43,086
and $34,168, respectively |
70,075 | 58,438 | ||||||
Goodwill |
5,603 | 4,477 | ||||||
Other intangible assets, net |
14,627 | 16,436 | ||||||
Other assets |
4,533 | 2,741 | ||||||
Total assets |
$ | 506,842 | $ | 360,589 | ||||
Liabilities and Stockholders’ Equity |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 11,739 | $ | 9,423 | ||||
Accrued and other current liabilities |
84,545 | 53,213 | ||||||
Total current liabilities |
96,284 | 62,636 | ||||||
Deferred income taxes |
16,449 | 23,883 | ||||||
Total liabilities |
112,733 | 86,519 | ||||||
Commitments and Contingencies (See Note 7) |
||||||||
Stockholders’ equity: (See Notes 1 and 2) |
||||||||
Preferred stock, $.10 par value, 15,000 shares authorized, none issued |
— | — | ||||||
Class A common stock, $.01 par value, 325,000 shares authorized and
132,555 shares issued and outstanding at September 30, 2004, 200,000
shares authorized and 128,674 shares issued and outstanding at
December 31, 2003(1) |
1,326 | 1,286 | ||||||
Class B common stock, $.01 par value, no shares authorized at
September 30, 2004, 25,000 shares authorized at December 31, 2003,
none outstanding |
— | — | ||||||
Additional paid-in-capital(1) |
167,992 | 117,811 | ||||||
Retained earnings |
220,614 | 150,973 | ||||||
Accumulated other comprehensive income |
4,177 | 4,000 | ||||||
Total stockholders’ equity |
394,109 | 274,070 | ||||||
Total liabilities and stockholders’ equity |
$ | 506,842 | $ | 360,589 | ||||
| (1) | Reflects a 2-for-1 stock split effected by a 100% stock dividend paid on June 17, 2004 (See Note 1). |
The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.
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COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(in thousands)
| For the Nine Months Ended | ||||||||
| September 30, |
||||||||
| 2004 |
2003 |
|||||||
Cash flows from operating activities: |
||||||||
Net income |
$ | 69,641 | $ | 39,640 | ||||
Adjustments to reconcile net income to net cash provided
by operating activities: |
||||||||
Depreciation and amortization |
11,776 | 8,397 | ||||||
Split-off costs (See Note 2) |
— | 2,010 | ||||||
Provision for doubtful accounts |
267 | 52 | ||||||
Deferred income taxes |
(7,434 | ) | 2,949 | |||||
Tax benefit related to option exercises |
26,522 | 13,228 | ||||||
Changes in assets and liabilities: |
||||||||
Trade accounts receivable |
(34,307 | ) | (15,669 | ) | ||||
Other current assets |
(22,714 | ) | (16,419 | ) | ||||
Other assets |
(1,539 | ) | 466 | |||||
Accounts payable |
2,316 | (1,276 | ) | |||||
Accrued and other liabilities |
31,008 | 8,582 | ||||||
Net cash provided by operating activities |
75,536 | 41,960 | ||||||
Cash flows from investing activities: |
||||||||
Purchases of property and equipment |
(21,791 | ) | (20,262 | ) | ||||
Investment in short-term bank deposits |
(43,351 | ) | — | |||||
Proceeds from maturity of short-term bank deposits |
23,033 | — | ||||||
Acquisition, net of cash acquired |
(1,495 | ) | (3,816 | ) | ||||
Net cash used in investing activities |
(43,604 | ) | (24,078 | ) | ||||
Cash flows from financing activities: |
||||||||
Proceeds from issued shares |
23,699 | 18,197 | ||||||
Split-off costs (See Note 2) |
— | (2,963 | ) | |||||
Net cash provided by financing activities |
23,699 | 15,234 | ||||||
Effect of currency translation on cash and cash equivalents |
518 | 422 | ||||||
Increase in cash and cash equivalents |
56,149 | 33,538 | ||||||
Cash and cash equivalents, beginning of year |
194,221 | 126,211 | ||||||
Cash and cash equivalents, end of period |
$ | 250,370 | $ | 159,749 | ||||
The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.
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COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(dollar amounts in thousands)
Note 1 — Interim Condensed Consolidated Financial Statements
The accompanying unaudited condensed consolidated financial statements included herein have been prepared by Cognizant Technology Solutions Corporation (“Cognizant” or the “Company”) in accordance with generally accepted accounting principles in the United States of America and Article 10 of Regulation S-X under the Securities and Exchange Act of 1934, as amended, and should be read in conjunction with the Company’s consolidated financial statements (and notes thereto) included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. In the opinion of the Company’s management, all adjustments considered necessary for a fair presentation of the accompanying unaudited condensed consolidated financial statements have been included, and all adjustments are of a normal and recurring nature. Operating results for the interim periods are not necessarily indicative of results that may be expected to occur for the entire year. Certain prior period amounts have been restated to conform to the presentation of the Company’s financial statements for fiscal year 2004.
On April 12, 2004, the Board of Directors declared a conditional two-for-one stock split to be effected by a 100% stock dividend payable on or about June 17, 2004 to stockholders of record as of May 27, 2004. The stock split was subject to stockholder approval at the Company’s May 26, 2004 Annual Meeting of Stockholders of an amendment to the Restated Certificate of Incorporation to increase the number of authorized shares of Class A common stock. On May 26, 2004, the Company’s stockholders approved such amendment to the Restated Certificate of Incorporation and as a result, a 100% stock dividend was paid on June 17, 2004 to stockholders of record as of May 27, 2004. The stock split has been reflected in the accompanying unaudited condensed consolidated financial statements, and all applicable references as to the number of outstanding common shares and per share information have been restated to reflect the stock split as if it occurred at the beginning of the earliest period presented. Stockholders’ equity accounts have been restated to reflect a $653 reclassification of an amount equal to the par value of the increase in issued shares of Class A common stock from the additional paid-in-capital account to the Class A common stock account. The amendment to the Restated Certificate of Incorporation increased the number of authorized shares of Class A common stock to 325,000,000 and eliminated the authorization of Class B common stock.
Note 2 — Split-Off from IMS Health and Related Party Transactions
On February 13, 2003 (the “Split-Off Date”), IMS Health Incorporated (“IMS Health”) distributed all of the Cognizant Class B common stock that IMS Health owned (a total of 67,745,400 shares) in an exchange offer to IMS Health stockholders (the “Split-Off”). In connection with the Split-Off, Cognizant was obligated under the provisions of an Intercompany Agreement with IMS Health to pay certain costs associated with the Split-Off. During the nine months ended September 30, 2003, Cognizant incurred direct and incremental costs of $2,010 related to the Split-Off. This amount was in addition to the approximately $1,700, which was
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recorded in the fourth quarter of 2002. Such costs included direct legal, accounting, printing and other costs. In addition, costs incurred in the first quarter of 2003 include a non-cash charge of approximately $488 calculated in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees and Related Interpretations” (“APB No. 25”) related to the retention, acceleration and extended life of Cognizant common stock options by two former Directors of Cognizant who resigned on the Split-Off Date as a condition of the Split-Off. As of the Split-Off Date, such former Directors were Officers of IMS Health. Cognizant did not receive any proceeds from the IMS Health exchange offer.
As a result of the Split-Off, IMS Health and its affiliates are no longer related parties of Cognizant as of the Split-Off Date. Only services rendered to or received from IMS Health and its affiliates during the period from January 1, 2003 to the Split-Off Date are classified as related party transactions. During the period from January 1, 2003 through the Split-Off Date, the Company recognized related party revenue of $2,575 and incurred costs of $28 for services provided by IMS Health to the Company.
The Company has a strategic relationship with The Trizetto Group Inc. (“Trizetto”) that includes helping its healthcare customers integrate Trizetto’s products with their existing information systems and, within Trizetto, supporting further development of these software applications. As of the Split-Off Date, IMS Health owned approximately 26.4% of the outstanding common stock of Trizetto. The Company recorded revenues from Trizetto of approximately $831 from January 1, 2003 through the Split-Off Date and recorded expenses related to Trizetto commissions of approximately $9 from January 1, 2003 through the Split-Off Date.
Note 3 — Acquisition
On February 27, 2004, the Company acquired Ygyan Consulting Private Ltd. (“Ygyan”), an India-based SAP services provider, for approximately $1,720 (including approximately $62 of estimated direct deal costs). Ygyan was acquired to increase the Company’s SAP service capabilities.
The Company has accounted for the acquisition as a business combination under the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations” and has made a preliminary assessment of the allocation of the purchase price to the tangible and intangible assets and liabilities acquired. Based upon that preliminary assessment, the Company expects that the amortization of such intangible assets will not have a material effect on the Company’s results of operations. The operating results of Ygyan have been included in the unaudited condensed consolidated financial statements since the acquisition date. The Ygyan acquisition was not material to the Company’s consolidated results of operations, cash flows or financial condition.
Note 4 — Investment in Short-Term Bank Deposits
The Company’s investments in bank deposits mature in less than one year. These short-term cash investments are valued at cost, which approximates fair value.
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Note 5 — Income Taxes
The Company’s Indian subsidiary, Cognizant 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 Cognizant India are attributable to export profits and are therefore currently substantially exempt from Indian income tax. These tax holidays began to expire in April 2004 and under current law will be completely phased out by March of 2009. The incremental Indian taxes related to the portion of the Indian tax holiday that expired in 2004 have been incorporated into the Company’s 2004 effective income tax rate. Such income taxes are estimated to be less than $10 million for 2004. The principal difference between the effective rates during the 2004 and 2003 periods and the Company’s United States federal statutory rate is the effect of the tax holiday in India.
Note 6 — Employee Stock-Based Employee Compensation Plans
On May 26, 2004, the Company adopted the 2004 Employee Stock Purchase Plan (the “Purchase Plan”) that provides for the issuance of up to 3,000,000 shares of Class A common stock to eligible employees. The Purchase Plan provides for eligible employees to designate, in advance of specified purchase periods, a percentage of compensation to be withheld from their pay and applied toward the purchase of such number of whole shares of Class A common stock as can be purchased at a price of 90% of the lesser of (a) the fair market value of a share of Class A common stock on the first date of the purchase period; or (b) the fair market value of a share of Class A common stock on the last date of the purchase period. No employee can purchase more than $25 worth of stock annually, and no stock can be purchased by any person which would result in the purchaser owning more than five percent or more of the total combined voting power or value of all classes of stock of the Company.
At September 30, 2004, the Company had four stock-based employee compensation plans. The Company accounts for these plans under the recognition and measurement principles of APB No. 25. Except as noted below, no stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share for the three months and nine months ended September 30, 2004 and 2003, if the Company had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation”, to stock-based employee compensation.
| Three Months | Three Months | Nine months | Nine months | |||||||||||||
| Ended | Ended | Ended | Ended | |||||||||||||
| September 30, | September 30, | September 30, | September 30, | |||||||||||||
| 2004 |
2003 |
2004 |
2003 |
|||||||||||||
Net income as reported |
$ | 26,052 | $ | 15,960 | $ | 69,641 | $ | 39,640 | ||||||||
Add: Stock-based
compensation, net
of tax benefit,
included in net
income |
— | — | — | 488 | ||||||||||||
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| Three Months | Three Months | Nine months | Nine months | |||||||||||||
| Ended | Ended | Ended | Ended | |||||||||||||
| September 30, | September 30, | September 30, | September 30, | |||||||||||||
| 2004 |
2003 |
2004 |
2003 |
|||||||||||||
Deduct: Total
stock-based
compensation
expense determined
under the fair
value method for
all awards, net of
tax related
benefits |
(4,587 | ) | (4,115 | ) | (12,463 | ) | (11,766 | ) | ||||||||
Pro forma net income |
$ | 21,465 | $ | 11,845 | $ | 57,178 | $ | 28,362 | ||||||||
Earnings per share: |
||||||||||||||||
As reported — basic |
$ | 0.20 | $ | 0.13 | $ | 0.53 | $ | 0.32 | ||||||||
Pro forma — basic |
$ | 0.16 | $ | 0.09 | $ | 0.44 | $ | 0.23 | ||||||||
As reported — diluted. |
$ | 0.18 | $ | 0.12 | $ | 0.49 | $ | 0.30 | ||||||||
Pro forma — diluted |
$ | 0.15 | $ | 0.09 | $ | 0.40 | $ | 0.21 | ||||||||
Note 7 — Commitments and Contingencies
The Company has expanded its plans to construct additional fully-owned development centers to now include over 900,000 square feet as compared to previous plans, announced in December 2003, to add 600,000 square feet of space. The new facilities will be located in Chennai, Pune, Calcutta and Bangalore, India. The total construction expenditure related to this expanded program is estimated to be approximately $76,000, an increase of approximately $34,000, when compared to the expansion program announced in December 2003. As of September 30, 2004, the Company has entered into fixed capital commitments of $2,168 related to this India development center expansion program, of which $1,330 has been spent to date.
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 the Company’s quarterly or annual operating results, cash flows, or consolidated financial position. Additionally, many of the Company’s engagements involve projects that are critical to the operations of its customers’ businesses and provide benefits that are difficult to quantify. Any failure in a customer’s computer system could result in a claim for substantial damages against the Company, regardless of the Company’s responsibility for such failure. Although the Company attempts to contractually limit its liability for damages arising from negligent acts, errors, mistakes, or omissions in rendering its software development and maintenance services, there can be no assurance that the limitations of liability set forth in its contracts will be enforceable in all instances or will otherwise protect the Company from liability for damages. Although the Company has general liability insurance coverage, including coverage for errors or omissions, there can be no assurance that such coverage will continue to be available on reasonable terms or will be available in sufficient amounts to cover one or more large claims, or that the insurer will not disclaim coverage as to any future claim. The successful assertion of one or more large claims against the Company that exceed available insurance coverage or changes in the Company’s insurance policies, including premium increases or the imposition of large deductible
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or co-insurance requirements, could have a material adverse effect on the Company’s business, results of operations, cash flows and financial condition.
In connection with the Split-Off, the Company entered into a Distribution Agreement, dated January 7, 2003, with IMS Health (the “Distribution Agreement”), that provides, among other things, that IMS Health and the Company will comply with, and not take any action during the relevant time period that is inconsistent with, the representations made to and relied upon by McDermott, Will & Emery in connection with rendering its opinion regarding the U.S. federal income tax consequences of the exchange offer. In addition, pursuant to the Distribution Agreement, the Company indemnified IMS Health for any tax liability to which they may be subject as a result of the exchange offer but only to the extent that such tax liability resulted solely from a breach in the representations the Company made to and were relied upon by McDermott, Will & Emery in connection with rendering its opinion regarding the U.S. federal income tax consequences of the exchange offer. If the Company breaches any of its representations in connection with the Distribution Agreement, the related indemnification liability could be material to the Company’s results of operations, financial position and cash flows.
Note 8 — Segment Information
The Company, operating globally, provides IT services for medium and large businesses. North American operations consist primarily of IT services in the United States and Canada. European operations consist of IT services principally in the United Kingdom, The Netherlands, Germany, Switzerland and Ireland. Asian operations consist of IT services principally in India, Singapore, Japan and Australia. 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 accordance with SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information”, information about the Company’s operations and total assets in North America, Europe and Asia for the three and nine month periods ended September 30, 2004 and September 30, 2003 are as follows:
| Three Months Ended | Nine Months Ended | |||||||||||||||||||
| September 30, |
September 30, |
|||||||||||||||||||
| 2004 |
2003 |
2004 |
2003 |
|||||||||||||||||
Revenues(1)(2) |
||||||||||||||||||||
North America(3) |
$ | 133,453 | $ | 87,272 | $ | 358,209 | $ | 230,595 | ||||||||||||
Europe |
20,755 | 10,153 | 52,515 | 27,524 | ||||||||||||||||
Asia |
1,221 | 686 | 3,168 | 1,954 | ||||||||||||||||
Consolidated |
$ | 155,429 | $ | 98,111 | $ | 413,892 | $ | 260,073 | ||||||||||||
Operating income(1) |
||||||||||||||||||||
North America(3) |
$ | 26,578 | $ | 17,145 | $ | 72,359 | $ | 45,154 | ||||||||||||
Europe |
4,133 | 1,994 | 10,602 | 5,389 | ||||||||||||||||
Asia |
243 | 135 | 638 | 383 | ||||||||||||||||
Other(4) |
(82 | ) | — | (1,250 | ) | — | ||||||||||||||
Consolidated |
$ | 30,872 | $ | 19,274 | $ | 82,349 | $ | 50,926 | ||||||||||||
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| As of | As of | |||||||
| September 30, | December 31, | |||||||
| 2004 |
2003 |
|||||||
Identifiable assets |
||||||||
North America(3) |
$ | 269,678 | $ | 203,168 | ||||
Europe |
30,805 | 26,045 | ||||||
Asia |
206,359 | 131,376 | ||||||
Consolidated |
$ | 506,842 | $ | 360,589 | ||||
| (1) | Revenues and resulting operating income in this schedule are attributed to regions based upon customer location. | |
| (2) | Application development and integration services represented approximately 47.0% and 42.4% of revenues during the three months ended September 30, 2004 and 2003, respectively and approximately 45.5% and 40.4% of revenues during the nine months ended September 30, 2004 and 2003, respectively. Application maintenance services represented approximately 53.0% and 57.6% of revenues during the three months ended September 30, 2004 and 2003, respectively and approximately 54.5% and 59.6% of revenues during the nine months ended September 30, 2004 and 2003, respectively. | |
| (3) | Primarily relates to operations in the United States. | |
| (4) | On June 29, 2004, the Company announced that it plans to wind-down operations at its development center located in Limerick, Ireland and close the facility by March 31, 2005. The costs associated with the closure of this facility have been disclosed separately since these costs were not allocated to a reporting segment in management’s internal reporting. The Company expects to incur during 2004 and 2005 incremental costs of approximately $1,500 associated with the closure of this facility. For the nine months ended September 30, 2004, the Company has recorded expenses of approximately $1,250 primarily for severance, retention bonuses and an obligation to repay funds previously received through local job grant programs and made payments of approximately $400 for severance and retention bonuses. Retention bonuses are being expensed over each eligible employee’s future service period. As of September 30, 2004, the Company had an accrual of approximately $850 for wind-down costs. Fixed assets related to this facility are not material and will be depreciated ratably through March 31, 2005. Approximately 50 employees are affected by the closure. |
During the three-month period ended September 30, 2004, JPMorgan Chase and another customer, each individually accounted for more than 10.0% of revenues and during the nine-month period ended September 30, 2004, JPMorgan Chase was the only customer to account for more than 10.0% of revenues. No customer accounted for more than 10.0% of revenues for the three and nine-month periods ended September 30, 2003.
Note 9 — Foreign Currency Forward Contract
During July 2004, the Company entered into a foreign currency forward contract, with a six-month term and notional amount of $12,500, to sell the Indian Rupee for U.S. dollars. We have entered into this forward contract to manage a portion of the Company’s foreign currency risk related to Indian Rupee denominated asset balances, primarily cash investments, at our
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Indian subsidiary, Cognizant India. Movement in the exchange rate for the Indian Rupee results in foreign currency gains or losses upon remeasurement of Cognizant India’s financial statements into its functional currency, the U.S. dollar. Our objective is to reduce foreign currency exposure to appreciation or depreciation in the value of the Indian Rupee by offsetting a portion of such exposure with gains or losses on the forward contract, referred to above.
At the end of each accounting period, the foreign currency forward contract will be marked-to-market and recorded at fair value with unrealized gains and losses reported along with foreign currency gains or losses in the caption “other income (expense), net” on the Company’s unaudited condensed consolidated statement of income. At September 30, 2004, the fair value of the foreign currency forward contract was a liability of $149. For the three and nine-month periods ended September 30, 2004, the unrealized loss on the foreign currency forward contract has been recorded as part of aggregate foreign currency transaction losses of $259 and $39, respectively.
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| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
Overview
We are a leading provider of custom IT services related to IT design, development, integration and maintenance services primarily for Fortune 1000 companies located in the United States and Europe. Our core competencies include web-centric applications, data warehousing, component-based development and legacy and client-server systems. We provide IT services 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.
During the three and nine months ended September 30, 2004, our revenue increased to $155.4 million and $413.9 million, respectively, compared to $98.1 million and $260.1 million for the three and nine months ended September 30, 2003. Net income increased to $26.1 million and $69.6 million, respectively or $0.18 and $0.49 per diluted share during the three and nine months ended September 30, 2004 compared to $16.0 million and $39.6 million, respectively or $0.12 and $0.30 per diluted share during the three and nine months ended September 30, 2003. Our revenue growth was driven by continued strong demand for our application management, and application development and integration services. Application management revenue increased by 45.6%, or approximately $25.8 million, from approximately $56.5 million during the three months ended September 30, 2003 to approximately $82.3 million during the three months ended September 30, 2004 and increased by 45.3%, or approximately $70.3 million, from approximately $155.1 million during the nine months ended September 30, 2003 to approximately $225.4 million during the nine months ended September 30, 2004. Application development and integration services increased by 75.8% and 79.6%, or approximately $31.5 million and $83.5 million, from approximately $41.6 million and $105.0 million during the three and nine months ended September 30, 2003 to approximately $73.1 million and $188.5 million during the three and nine months ended September 30, 2004. As of September 30, 2004, our number of active clients increased to 219 compared to 213 at June 30, 2004 and 153 at December 31, 2003. We anticipate that a significant portion of our revenue growth for the remainder of 2004 will come from an increased level of work at existing clients. We continue to see an increased level of interest for offshore services in Northern Europe. During the three months ended September 30, 2004, our operating margin increased to 19.9% compared to 19.6% for the three months ended September 30, 2003. This was consistent with our targeted operating margin range of 19% to 20% of total revenues. Currently, it is our intent to reinvest earnings in excess of our targeted operating margin range back into the business principally to expand our service capabilities and sales and marketing efforts.
At September 30, 2004, we had cash and cash equivalents and short-term bank deposits of $270.4 million, an increase of $76.2 million compared to December 31, 2003. Our most recent building plans provide for construction of approximately 900,000 square feet of space in new fully-owned development centers located in Chennai, Pune, Calcutta and Bangalore, India. This supercedes our previous plans, announced in December 2003, which included 600,000 square feet of new space. Total construction costs related to this program are currently estimated to be approximately $76.0 million, which we expect to fund from current operations. We believe
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our financial condition will remain strong. In addition, we will continue to consider acquisitions of companies that can improve our capabilities in certain market niches or geographic areas.
On June 29, 2004, we announced our plans to wind-down operations at our development center located in Limerick, Ireland and close the facility by March 31, 2005. We decided to close this facility due to the increased cost structure resulting from the significant appreciation in the value of the Euro against the US dollar since the facility was acquired in 2002. All work currently performed in this facility will be transferred to Cognizant’s operations in North America and India. Currently, we expect to incur during 2004 and 2005 incremental costs of approximately $1.5 million associated with the closure of this facility. For the nine months ended September 30, 2004, we have recorded expenses of approximately $1.3 million primarily for severance, retention bonuses and an obligation to repay funds previously received through local job grant programs and made payments of approximately $0.4 million for severance and retention bonuses. Approximately 50 employees are affected by the closure.
On April 12, 2004, our Board of Directors declared a conditional two-for-one stock split to be effected by a 100% stock dividend payable on or about June 17, 2004 to stockholders of record as of May 27, 2004. The stock split was subject to stockholder approval at the May 26, 2004 Annual Meeting of Stockholders of an amendment to our Restated Certificate of Incorporation to increase the number of authorized shares of Class A common stock. On May 26, 2004, our stockholders approved such amendment to our Restated Certificate of Incorporation and as a result, a 100% stock dividend was paid on June 17, 2004 to stockholders of record as of May 27, 2004. The stock split has been reflected in the accompanying consolidated financial statements, and all applicable references as to the number of outstanding common shares and per share information have been restated to reflect the stock split as if it occurred at the beginning of the earliest period presented. Stockholders’ equity accounts have been restated to reflect a reclassification of approximately $0.7 million of an amount equal to the par value of the