SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2002
Commission File No. 0-24429
Cognizant Technology Solutions Corporation
------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
Delaware 13-3728359
- ------------------------------- ------------------------------------
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
500 Glenpointe Centre West, Teaneck, New Jersey 07666
- --------------------------------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
(201) 801-0233
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(Registrant's Telephone Number,
Including Area Code)
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 whether the Registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act)
Yes: [X] No: [ ]
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of October 31, 2002:
Class Number of Shares
----- ----------------
Class A Common Stock, par 8,850,276
value $.01 per share
Class B Common Stock, par
value $.01 per share 11,290,900
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
TABLE OF CONTENTS
Page
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PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements (Unaudited).................... 1
Condensed Consolidated Statements of Income and Comprehensive Income
(Unaudited) for the Three Months and Nine Months Ended September 30, 2002
and 2001................................................................... 2
Condensed Consolidated Statements of Financial
Position (Unaudited) as of September 30, 2002 and December 31, 2001 ....... 3
Condensed Consolidated Statements of Cash Flows (Unaudited) for the Nine
Months Ended September 30, 2002 and 2001................................... 4
Notes to Condensed Consolidated Financial Statements
(Unaudited)................................................................ 5
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition.............................. 12
Item 3. Quantitative and Qualitative Disclosures About
Market Risk ............................................................... 22
Item 4. Controls and Procedures.................................................... 22
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K........................................... 23
SIGNATURES............................................................................. 24
CERTIFICATIONS......................................................................... 25
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PART I. FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
-1-
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,
------------------------------ -----------------------------
2002 2001 2002 2001
--------- --------- --------- ---------
Revenues .......................................... $ 55,714 $ 40,403 $ 146,510 $ 120,803
Revenues - related party .......................... 5,519 5,099 15,565 13,514
--------- --------- --------- ---------
Total revenues ................................. 61,233 45,502 162,075 134,317
Cost of revenues .................................. 32,970 23,109 86,507 68,859
--------- --------- --------- ---------
Gross profit ...................................... 28,263 22,393 75,568 65,458
Selling, general and administrative
expenses ....................................... 14,150 11,441 37,933 34,306
Depreciation and amortization expense ............. 2,005 1,629 5,679 4,566
--------- --------- --------- ---------
Income from operations ............................ 12,108 9,323 31,956 26,586
Other income (expense):
Interest income ................................ 471 643 1,305 2,006
Other income (expense) - net ................... 24 (209) (89) (604)
--------- --------- --------- ---------
Total other income ....................... 495 434 1,216 1,402
--------- --------- --------- ---------
Income before provision for income taxes .......... 12,603 9,757 33,172 27,988
Provision for income taxes ........................ (2,936) (3,649) (7,749) (10,468)
--------- --------- --------- ---------
Net income ........................................ $ 9,667 $ 6,108 $ 25,423 $ 17,520
========= ========= ========= =========
Basic earnings per share .......................... $ 0.49 $ 0.32 $ 1.30 $ 0.93
========= ========= ========= =========
Diluted earnings per share ........................ $ 0.45 $ 0.30 $ 1.21 $ 0.86
========= ========= ========= =========
Weighted average number of common
shares outstanding - Basic ..................... 19,862 19,184 19,618 18,896
========= ========= ========= =========
Dilutive effect of shares issuable as of period-end
under stock option plans ....................... 1,589 1,331 1,422 1,486
========= ========= ========= =========
Weighted average number of common
shares outstanding - Diluted ................... 21,451 20,515 21,040 20,382
========= ========= ========= =========
Comprehensive income:
Net income ........................................ $ 9,667 $ 6,108 $ 25,423 $ 17,520
Foreign currency translation adjustments .......... (194) 50 (98) (59)
--------- --------- --------- ---------
Comprehensive income .............................. $ 9,473 $ 6,158 $ 25,325 $ 17,461
========= ========= ========= =========
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,
2002 2001
--------- ---------
ASSETS
Current assets:
Cash and cash equivalents ....................................... $ 123,082 $ 84,977
Trade accounts receivable, net of allowance of $881 and
$882, respectively ........................................... 30,206 21,063
Trade accounts receivable-related party ......................... 1,614 1,481
Unbilled accounts receivable .................................... 6,719 5,005
Unbilled accounts receivable-related party ...................... 818 417
Other current assets ............................................ 6,877 4,392
--------- ---------
Total current assets ........................................ 169,316 117,335
--------- ---------
Property and equipment, net of accumulated depreciation of $22,622 and
$16,805, respectively .............................................. 25,906 24,339
Goodwill, net ........................................................ 878 878
Other assets ......................................................... 4,676 2,431
--------- ---------
Total assets ................................................ $ 200,776 $ 144,983
--------- =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ................................................ $ 4,817 $ 3,652
Accrued and other current liabilities ........................... 27,865 18,046
--------- ---------
Total current liabilities ................................... 32,682 21,698
Deferred income taxes ................................................ 25,472 24,493
--------- ---------
Total liabilities ........................................... 58,154 46,191
--------- ---------
Commitments and Contingencies (Note 7)
Stockholders' equity:
Preferred stock, $.10 par value, 15,000 shares authorized, none issued -- --
Class A common stock, $.01 par value, 100,000 shares authorized,
8,745 shares and 8,065 shares issued and outstanding at
September 30, 2002 and December 31, 2001, respectively .......... 87 80
Class B common stock, $.01 par value, 25,000 shares authorized,
11,291 shares issued and outstanding at September 30, 2002 and
December 31, 2001, respectively ................................ 113 113
Additional paid-in-capital ........................................... 58,209 39,711
Retained earnings .................................................... 84,469 59,046
Cumulative translation adjustment .................................... (256) (158)
--------- ---------
Total stockholders' equity .................................. 142,622 98,792
--------- ---------
Total liabilities and stockholders' equity .................. $ 200,776 $ 144,983
========= =========
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,
-----------------------------
2002 2001
--------- ---------
Cash flows from operating activities:
Net income .......................................................... $ 25,423 $ 17,520
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization .............................. 5,679 4,566
Provision for doubtful accounts ............................ 541 1,388
Deferred income taxes ...................................... 979 5,675
Tax benefit related to option exercises .................... 5,545 4,101
Changes in assets and liabilities:
Trade accounts receivable .................................. (9,817) (1,320)
Other current assets ....................................... (4,600) (5,318)
Other assets ............................................... 852 133
Accounts payable ........................................... 1,165 146
Accrued and other liabilities .............................. 9,819 (3,176)
--------- ---------
Net cash provided by operating activities ........................... 35,586 23,715
--------- ---------
Cash flows from investing activities:
Purchases of property and equipment-net ............................. (7,599) (10,691)
Acquisition of assets ............................................... (2,744) --
--------- ---------
Net cash used in investing activities ............................... (10,343) (10,691)
--------- ---------
Cash flows from financing activities:
Proceeds from issued shares/contributed capital ..................... 12,960 4,818
Payments to related party ........................................... -- 8
--------- ---------
Net cash provided by financing activities ........................... 12,960 4,826
--------- ---------
Effect of currency translation ...................................... (98) (59)
--------- ---------
Increase in cash and cash equivalents ............................... 38,105 17,791
Cash and cash equivalents, beginning of year ........................ 84,977 61,976
--------- ---------
Cash and cash equivalents, end of period ............................ $ 123,082 $ 79,767
========= =========
The accompanying notes are an integral part of the unaudited condensed
consolidated financial statements.
-4-
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(DOLLAR AMOUNTS IN THOUSANDS)
NOTE 1 - INTERIM UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS:
The accompanying unaudited condensed consolidated financial statements
included herein have been prepared by Cognizant Technology Solutions Corporation
(the "Company") in accordance with generally accepted accounting principles in
the United States 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 2001 Annual Report on Form 10-K and the Company's unaudited condensed
consolidated financial statements (and notes thereto) included in the Company's
Quarterly Reports on Form 10-Q for the periods ended March 31, 2002 and June 30,
2002. 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 period are not
necessarily indicative of results that may be expected to occur for the entire
year. Certain prior-year amounts have been reclassified to conform to the 2002
presentation.
NOTE 2 - ACQUISITION OF ASSETS:
On June 30, 2002, Cognizant Technology Solutions Ireland Limited ("CTS
Ireland"), a newly formed, wholly-owned subsidiary of the Company, purchased
certain assets and assumed certain liabilities from UnitedHealthcare Ireland
Limited ("UHC Ireland"), a subsidiary of UnitedHealth Group, for $2,900. UHC
Ireland previously provided, and will continue to provide through CTS Ireland,
application design, development and maintenance services, using its existing
staff of 70 Information Technology ("IT") professionals. The acquisition of the
assets of UHC Ireland will enable the Company to provide a wide range of
services to the Company's clients in Europe and worldwide and represents the
initial phase of the implementation of the Company's previously announced
international expansion strategy.
The Company has completed a preliminary assessment of the allocation of
the purchase price to the tangible and amortizable intangible assets acquired
and liabilities assumed. Based upon that preliminary assessment, the Company has
assigned estimated values to the workforce and customer relationship acquired,
and expects the useful lives of such assets to range between three and ten
years. Amortization expense associated with these intangible assets of $114 has
been included in the Company's Statements of Operations for the three and
nine-month periods ended September 30, 2002. The Company expects that
adjustments related to the finalization of the valuation of such intangible
assets will not have a material effect on the Company's results of operations.
Pending finalization of the valuation, the purchase price, net of amounts
assigned to fixed assets of approximately $260, has been included in long-term
"Other Assets" in the accompanying Balance Sheet. Such net assets have been
included as identifiable assets in the European segment in Note 8 of the Notes
to the Unaudited Condensed Consolidated Financial Statements.
The results of CTS Ireland have been included in the unaudited condensed
consolidated financial statements of the Company effective July 1, 2002.
-5-
NOTE 3 - COMPREHENSIVE INCOME:
The Company's Comprehensive Income consists of net income and foreign
currency translation adjustments. Accumulated balances of Cumulative Translation
Adjustments, as of September 30, 2002 and September 30, 2001 are as follows:
Cumulative
Translation
Adjustment
Balance, December 31, 2001................................. $ (158)
Foreign currency translation adjustments................... (98)
---------
Balance, September 30, 2002................................ $ (256)
=========
Balance, December 31, 2000................................. $ (50)
Foreign currency translation adjustments................... (59)
---------
Balance, September 30, 2001................................ $ (109)
=========
NOTE 4 - RELATED PARTY TRANSACTIONS AND TRANSACTIONS WITH AFFILIATES:
As of September 30, 2002, IMS Health Incorporated ("IMS Health") owned
56.4% of the outstanding common stock of the Company (representing all of the
Company's Class B common stock) and held 92.8% of the combined voting power of
the Company's common stock. Holders of Class A common stock have one vote per
share and holders of Class B common stock have ten votes per share. Holders of
Class B common stock are entitled to convert their shares into shares of Class A
common stock at any time on a share for share basis. Shares of Class B common
stock transferred to stockholders of IMS Health in a transaction intended to be
on a tax-free basis (a "Tax-Free Transaction") under the Internal Revenue Code
shall not convert into shares of Class A common stock upon the occurrence of
such Tax-Free Transaction. No preferred stock has been issued.
IMS Health currently provides the Company with certain administrative
services including payroll and payables processing and permits the Company to
participate in certain of IMS Health's business insurance plans. In prior
periods, IMS Health provided certain other services such as tax planning and
compliance, which have since been transitioned to the Company. All services are
performed and charged to the Company under an intercompany services agreement
with IMS Health. Total costs in connection with these services were
approximately $139 and $110 for the three-month periods ended September 30, 2002
and 2001, respectively. Total costs in connection with these services were
approximately $417 and $330 for the nine-month periods ended September 30, 2002
and 2001, respectively.
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 September
30, 2002, IMS Health owned approximately 26.5% of the outstanding common stock
of TriZetto. During the three- and nine-month periods ended September 30, 2002,
the Company recorded revenues from TriZetto of approximately $1,199 and $1,302,
respectively, and recorded expense related to TriZetto commissions of
approximately $123 and $456 for the three- and nine-month periods ended
September 30, 2002, respectively. During the three- and nine-month periods ended
September 30, 2001, the Company recorded revenues from TriZetto of approximately
$401 and recorded expense related to TriZetto commissions of approximately $0
and $793 for the three- and nine-month periods ended September 30, 2001,
respectively.
Other related party disclosures are included in Note 8 of the Notes to the
Unaudited Condensed Consolidated Financial Statements.
-6-
NOTE 5 - INCOME TAXES:
The Company'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. These tax holidays will begin to expire in 2004 and under current
law will be completely phased out by March of 2009. In prior years, it was
management's intent to repatriate all accumulated earnings from India to the
United States; accordingly, the Company has provided deferred income taxes in
the amount of approximately $25,535 on all such undistributed earnings through
December 31, 2001.
During the first quarter of 2002, the Company 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, the Company 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, the Company 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 September 30, 2002, the amount of unrepatriated earnings upon
which no provision for taxation has been recorded is approximately $21,224. If
such earnings are repatriated in the future, or are no longer deemed to be
indefinitely reinvested, the Company will accrue the applicable amount of taxes
associated with such earnings. This change in intent, as well as a change in the
second quarter in the manner in which repatriated earnings are taxed in India,
resulted in an estimated effective tax rate for the three- and nine-month
periods ended September 30, 2002 of 23.3% and 23.4%, respectively. These rates
compare to an effective tax rate for the three- and nine-month periods ended
September 30, 2001 of 37.4%.
During the nine-month period ended September 30, 2002, stock option
exercises resulted in a tax benefit to the Company of approximately $5,546. This
benefit is netted against certain short-term tax obligations and included in the
caption "Other Current Assets" on the accompanying balance sheet.
NOTE 6 - ADOPTION OF STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS:
Statements of Financial Accounting Standards Adopted:
In June 2001, Statement of Financial Accounting Standards No. 141,
"Business Combinations" ("FAS 141") and Statement of Financial Accounting
Standards No. 142 "Goodwill and Other Intangible Assets" ("FAS 142") were
issued. FAS 141 requires the purchase method of accounting to be used for all
business combinations initiated after June 30, 2001. FAS 141 also specifies
criteria that intangible assets acquired must meet to be recognized and reported
separately from goodwill. FAS 142 requires that goodwill and intangible assets
with indefinite lives no longer be amortized but instead be measured for
impairment at least annually, or when events indicate that there may be an
impairment. FAS 142 is effective for fiscal years beginning after December 15,
2001. The adoption of FAS 141 and FAS 142 did not have a material effect on the
Company's financial position or results of operations. The following table sets
forth the Company's results had FAS 142 been applied to the prior-period
financial statements presented herein.
-7-
THREE MONTHS ENDED NINE MONTHS
ENDED ENDED
SEPTEMBER 30, 2001 SEPTEMBER 30, 2001
------------------ ------------------
Reported Net Income $ 6,108 $ 17,520
Reversal of Goodwill Amortization - net of tax 79 238
--------- -----------
Adjusted Net Income excluding Goodwill Amortization $ 6,187 $ 17,758
Adjusted Basic EPS excluding Goodwill Amortization $ 0.32 $ 0.94
Adjusted Diluted EPS excluding Goodwill Amortization $ 0.30 $ 0.87
In August 2001, Statement of Financial Accounting Standards No. 144,
"Accounting for the Impairment or Disposal of Long-lived Assets" ("FAS 144") was
issued. FAS 144 supersedes Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-lived Assets to be Disposed of," and the
accounting and reporting provisions of Accounting Principles Board Opinion No.
30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently occurring
Events and Transactions." FAS 144 also amends Accounting Research Bulletin No.
51, "Consolidated Financial Statements", to eliminate the exception to
consolidation for a subsidiary for which control is likely to be temporary. FAS
144 retains the fundamental provisions of FAS 121 for recognizing and measuring
impairment losses on long-lived assets held for use and long-lived assets to be
disposed of by sale, while resolving significant implementation issues
associated with FAS 121. Among other things, FAS 144 provides guidance on how
long-lived assets used as part of a group should be evaluated for impairment,
establishes criteria for when long-lived assets are held for sale, and
prescribes the accounting for long-lived assets that will be disposed of other
than by sale. FAS 144 is effective for fiscal years beginning after December 15,
2001. The adoption of FAS 144 did not have a material impact on the Company's
financial position and results of operations.
In April 2002, Statement of Financial Accounting Standards No. 145,
"Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement
No. 13, and Technical Corrections" ("FAS 145") was issued. FAS 145 updates,
clarifies and simplifies existing accounting pronouncements and is generally
effective for transactions occurring after May 15, 2002. The adoption of this
statement did not have a material impact on the Company's financial position or
results of operations.
Statements of Financial Accounting Standards Not Yet Adopted:
In June 2001, Statement of Financial Accounting Standards No. 143,
"Accounting for Asset Retirement Obligations" ("FAS 143") was issued. FAS 143
addresses financial accounting and reporting for legal obligations associated
with the retirement of tangible long-lived assets and the associated retirement
costs that result from the acquisition, construction, or development and normal
operation of a long-lived asset. Upon initial recognition of a liability for an
asset retirement obligation, FAS 143 requires an increase in the carrying amount
of the related long-lived asset. The asset retirement cost is subsequently
allocated to expense using a systematic and rational method over the asset's
useful life. FAS 143 is effective for fiscal years beginning after June 15,
2002. The adoption of this statement is not expected to have a material impact
on the Company's financial position or results of operations.
In June 2002, Statement of Financial Accounting Standards No. 146,
"Accounting for Exit or Disposal Activities" ("FAS 146") was issued. FAS 146
addresses the accounting for costs to terminate a contract that is not a capital
lease, costs to consolidate facilities and relocate employees, and involuntary
termination benefits under one-time benefit arrangements that are not an ongoing
benefit program or an individual deferred compensation contract. A liability for
contract termination costs should be recognized and measured at fair value
either when the contract is terminated or when the entity ceases to use the
right conveyed by the contract. A liability for one-time termination benefits
should be recognized and measured at fair value at the communication date if the
employee would not be retained beyond a minimum retention period (i.e., either a
legal notification period or 60 days, if no legal requirement exists). For
employees that will be retained beyond the minimum retention period, a liability
should be accrued ratably over the future service period. The provisions of the
statement will be effective for disposal activities initiated after December 31,
2002. The adoption of this statement is not expected to have a material impact
on the Company's financial position or results of operations.
-8-
In October 2002, Statement of Financial Accounting Standards No. 147,
"Acquisitions of Certain Financial Institutions" ("FAS 147") was issued. FAS 147
addresses the financial accounting and reporting for the acquisition of all or
part of a financial institution, except for a transaction between two or more
mutual enterprises. FAS 147 also provides guidance on the accounting for the
impairment or disposal of acquired long-term customer-relationship intangible
assets, including those acquired in transactions between two or more mutual
enterprises. The provisions of the statement will be effective for acquisitions
for which the date of acquisition is on or after October 1, 2002. The adoption
of this statement is not expected to have a material impact on the Company's
financial position or results of operations.
NOTE 7 - CONTINGENCIES AND COMMITMENTS:
As of September 30, 2002, the Company has entered into fixed capital
commitments related to its India development center expansion program of
approximately $20,109, of which approximately $10,924 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' business 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 by contract to limit its liability for
damages arising from negligent acts, errors, mistakes, or omissions in rendering
its application design, 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 or co-insurance
requirements, could have a material adverse effect on the Company's business,
results of operations and financial condition.
-9-
NOTE 8 - SEGMENT INFORMATION:
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. The Company's core competencies include
web-centric applications, data warehousing, component-based development and
legacy and client-server systems. The Company provides the IT services it offers
using an integrated on-site/offshore business model. This seamless
onsite/offshore 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. North American operations consist primarily of
application design, development and maintenance services in the United States
and Canada. European operations consist primarily of application design,
development and maintenance services principally in the United Kingdom, Germany
and Ireland. European identifiable assets include the net assets resulting from
the acquisition of certain assets and liabilities from UHC Ireland (See Note 2
to the Notes to the Unaudited Condensed Consolidated Financial Statements).
Asian operations consist primarily of application design, development and
maintenance 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. Revenues and resulting operating income are attributed to regions
based upon customer location, and exclude the effect of intercompany revenue for
services provided by CTS India to other CTS entities.
Information about the Company's operations and total assets in North
America, Europe and Asia for the periods ended September 30, 2002 and 2001 are
presented in accordance with Statement of Financial Accounting Standard No. 131,
"Disclosures About Segments of an Enterprise and Related Information," as
follows:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
2002 2001 2002 2001
-------- -------- -------- --------
REVENUES (1)
North America (2) $ 52,913 $ 39,432 $140,445 $115,989
Europe 8,032 5,665 20,398 17,203
Asia 288 405 1,232 1,125
-------- -------- -------- --------
Consolidated $ 61,233 $ 45,502 $162,075 $134,317
======== ======== ======== ========
OPERATING INCOME (1)
North America (2) $ 10,463 $ 8,079 $ 27,692 $ 22,959
Europe 1,588 1,161 4,021 3,403
Asia 57 83 243 224
-------- -------- -------- --------
Consolidated $ 12,108 $ 9,323 $ 31,956 $ 26,586
======== ======== ======== ========
AS OF SEPTEMBER 30,
----------------------
IDENTIFIABLE ASSETS 2002 2001
-------- --------
North America (2) $ 84,458 $ 89,576
Europe 11,741 5,946
Asia 104,577 43,051
-------- --------
Consolidated $200,776 $138,573
======== ========
(1) Revenues and resulting operating income are attributed to regions based
upon customer location.
(2) Primarily relates to operations in the United States.
In the third quarter of 2002, sales to one related party customer (IMS
Health) accounted for 9.0% of revenues and sales to one third-party customer
(Metropolitan Life Insurance Company) accounted for 11.5% of revenues. In the
third quarter of 2001, sales to one related party customer (IMS Health)
accounted for 11.2% of revenue and no third party accounted for sales in excess
of 10% of revenue. During the nine months ended September 30, 2002, sales to
IMS Health accounted for 9.6% of revenues and no third party customer accounted
for
-10-
sales in excess of 10% of revenue. During the none months ended September 30,
2001 sales to IMS Health accounted for 10.1% of revenues and no third party
customer accounted for sales in excess of 10% of revenue.
Revenues related to services performed without a signed agreement or work
order are not recognized until such agreements or work orders are signed;
however the cost related to the performance of such work is recognized in the
period the services are rendered.
A majority of the Company's employees and a significant portion of the
Company's assets are located in India. Accordingly, the Company bears certain
geo-political risks of local and cross-border conflicts within this geographic
region.
NOTE 9 - SUBSEQUENT EVENTS:
Acquisition of Assets
On October 29, 2002, the Company completed the transfer of Silverline
Technologies, Inc.'s American Express practice to the Company. The Company will
now provide application design, development and maintenance services to American
Express through an acquired workforce of approximately three hundred IT and
support professionals located primarily in the United States and India.
The Company has commenced a preliminary assessment of the allocation of
the consideration paid of approximately $10,400 to the amortizable intangible
assets acquired in this transaction. Since the transfer was effected on October
29, 2002, the results of operations of this transfer will be included in the
consolidated financial statements of the Company commencing from that date. The
operating results from this transaction are not expected to be material to the
Company.
Proposed Split-off Transaction
The Company intends to file a registration statement on Form S-4 with the
Securities and Exchange Commission (SEC) concurrently with the filing of this
Quarterly Report. The registration statement is being filed for the purpose of
registering a proposed offer by IMS Health to exchange shares of the Company's
Class B common stock owned by IMS Health for a yet to be determined number of
shares of common stock of IMS Health (the "Exchange Offer"). At September 30,
2002, IMS Health owned approximately 56.4% of the outstanding stock of the
Company (representing all of the Company's outstanding Class B common stock) and
held approximately 92.8% of the combined voting power of the Company's
outstanding common stock. It is expected that IMS Health will seek to exchange
up to 11,291 shares of the Company's Class B common stock in the Exchange Offer,
representing all Class B shares of the Company that are currently owned by IMS
Health. The exchange offer, which is subject to SEC review and certain
conditions, is expected to occur in the first quarter of 2003. The Company
expects to incur significant costs in connection with this proposed transaction.
Such costs will be expensed as incurred.
The shares of the Company's Class B common stock are identical to the
shares of the Company's Class A common stock, except that a holder of shares of
Class B common stock is entitled to 10 votes per share, while a holder of shares
of Class A common stock is entitled to one vote per share. Each share of Class B
received in the Exchange Offer will convert automatically into one share of
Class A common stock when it is transferred after the Exchange Offer as well as
under certain other specified circumstances. The Class B common stock will not
be separately listed or quoted on any exchange and will not trade separately.
There will be no impact on the number of the Company's total shares
outstanding as a result of the Exchange Offer.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION.
GENERAL
The Company is a leading provider of custom Information Technology ("IT")
design, development, integration and maintenance services primarily for Fortune
1000 companies located in the United States and Europe. The Company's core
competencies include web-centric applications, data warehousing, component-based
development and legacy and client-server systems. The Company 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. The Company 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, the Company, along with certain other entities.
was spun-off from The Dun & Bradstreet Corporation to form a new company,
Cognizant Corporation. On June 24, 1998, the Company completed its initial
public offering. On June 30, 1998, a majority interest in the Company, 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 September 30, 2002, IMS Health
owned 56.4% of the outstanding stock of the Company (representing all of the
Company's Class B common stock) and held 92.8% of the combined voting power of
the Company's common stock. Holders of the Company's Class A common stock have
one vote per share and holders of the Company's Class B common stock have ten
votes per share.
The Company intends to file a registration statement on Form S-4 with the
Securities and Exchange Commission (SEC) concurrently with the filing of the
Quarterly Report of which this discussion is a part. The registration statement
is being filed for the purpose of registering a proposed offer by IMS Health to
exchange shares of the Company's Class B common stock owned by IMS Health for a
yet to be determined number of shares of common stock of IMS Health (the
"Exchange Offer"). It is expected that IMS Health will seek to exchange up to
11,291 shares of the Company's Class B common stock in the Exchange Offer,
representing all Class B shares of the Company that are currently owned by IMS
Health. The exchange offer, which is subject to SEC review and certain
conditions, is expected to occur in the first quarter of 2003.
The shares of the Company's Class B common stock are identical to the
shares of the Company's Class A common stock, except that a holder of shares of
Class B common stock is entitled to 10 votes per share, while a holder of shares
of Class A common stock is entitled to one vote per share. Each share of Class B
received in the Exchange Offer will convert automatically into one share of
Class A common stock when it is transferred after the Exchange Offer as well as
under certain other specified circumstances. The Class B common stock will not
be separately listed or quoted on any exchange and will not trade separately.
There will be no impact on the number of the Company's total shares outstanding
as a result of the Exchange Offer. However, the Exchange Offer may impact the
Company in a number of ways and these impacts could be significant. Reference is
made to Exhibit 99.2 to this Quarterly Report which contains a excerpt from the
registration statement on Form S-4 discussing risk factors relating to the
Exchange Offer. The Company expects to incur charges in the fourth quarter of
2002 and the first quarter of 2003 aggregating between $2 to $3 million in
relation to one-time costs associated with the Exchange Offer.
Revenue Recognition. The Company's services are performed on either a
time-and-materials or fixed-price basis. Revenues related to time-and-materials
contracts are recognized as the service is performed. Revenues related to
fixed-price contracts primarily relate to application development and
significant application enhancement projects. Revenues related to such
fixed-price contracts are recognized using the percentage-of-completion method
of accounting, under which the sales value of performance, including earnings
thereon, is recognized on the basis of the percentage that each contract's
incurred cost to date bears to the total estimated cost. The Company does not
incur significant up-front costs associated with these fixed-price contracts and
all costs related to the services provided are expensed as incurred. Estimates
are subject to adjustment as a project progresses to reflect changes
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in expected completion costs or dates. The cumulative impact of any revision in
estimates of the percentage of work completed is reflected in the financial
reporting period in which the change in the estimate becomes known, and any
anticipated losses are recognized immediately. The Company's failure to estimate
accurately the resources and time required for a fixed-price project, or its
failure to complete its contractual obligations within the time frame committed,
could have a material adverse effect on the Company's business, results of
operations and financial condition.
Revenues related to services performed without a signed agreement or work
order are not recognized until such agreements or work orders are signed;
however the cost related to the performance of such work is recognized in the
period the services are rendered.
CHANGES TO CRITICAL ACCOUNTING POLICIES, ESTIMATES AND RISKS
The Company's critical accounting policies are set forth in its Annual
Report on Form 10-K for the year ended December 31, 2001. The following sets
forth changes to risks and critical accounting policies:
Tensions between the United States and Iraq have recently escalated as the
United States has threatened to take military action against Iraq. Hostilities
involving the United States, or military or travel disruptions and restrictions
affecting the Company's employees, could materially adversely affect the
Company's operations and its ability to service its customers. Approximately 72%
of the Company's technical professionals are located in India, and the vast
majority of the Company's technical professionals in the United States and
Europe are Indian nationals who are able to work in the United States only
because they hold current visas. A military action by the United States against
Iraq would likely further disrupt travel and the ability to obtain visas to
enter into the United States. Travel restrictions could cause the Company to
incur additional unexpected labor costs and expenses or could restrain the
Company's ability to retain the skilled professionals it needs for its
operations in the United States and Europe. Accordingly, hostilities between the
United States and Iraq could adversely affect the Company's business, financial
condition and results of operations and impair its ability to service its
customers.
Income Taxes. The Company'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. These tax holidays will begin to expire in 2004 and under
current law will be completely phased out by March of 2009. In prior years, it
was management's intent to repatriate all accumulated earnings from India to the
United States; accordingly, the Company has provided deferred income taxes in
the amount of approximately $25.5 million dollars on all such undistributed
earnings through December 31, 2001. During the first quarter of 2002, the
Company 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, the Company 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, the
Company 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. If such earnings are
repatriated in the future, or are no longer deemed to be indefinitely
reinvested, the Company will accrue the applicable amount of taxes associated
with such earnings. 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 three and nine months ended September 30, 2002 of
23.3% and 23.4%, respectively. These rates compare to an effective tax rate for
the three and nine month periods ended September 30, 2001 of 37.4%.
* * * * * * * * *
The statements contained in this Quarterly Report on Form 10-Q that are
not historical facts are forward-looking statements (within the meaning of
Section 21E of the Securities Exchange Act of 1934, as amended) that involve
risks and uncertainties. Such forward-looking statements may be identified by,
among other things, the use
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of forward-looking terminology such as "believes," "expects," "may," "will,"
"should" or "anticipates" or the negative thereof or other variations thereon or
comparable terminology, or by discussions of strategy that involve risks and
uncertainties. From time to time, the Company or its representatives have made
or may make forward-looking statements, orally or in writing. Such
forward-looking statements may be included in various filings made by the
Company with the Securities and Exchange Commission, or press releases or oral
statements made by or with the approval of an authorized executive officer of
the Company. These forward-looking statements, such as statements regarding
anticipated future revenues, contract percentage completions, capital
expenditures, and other statements regarding matters that are not historical
facts, involve predictions. The Company's actual results, performance or
achievements could differ materially from the results expressed in, or implied
by, these forward-looking statements. Potential risks and uncertainties that
could affect the Company's future operating results include, but are not limited
to: (i) the significant fluctuations of the Company's quarterly operating
results caused by a variety of factors, many of which are not within the
Company's control, including (a) the number, timing, scope and contractual terms
of application design, development and maintenance projects, (b) delays in the
performance of projects, (c) the accuracy of estimates of costs, resources and
time to complete projects, (d) seasonal patterns of the Company's services
required by customers, (e) levels of market acceptance for the Company's
services, (f) potential adverse impacts of new tax legislation, and (g) the
hiring of additional staff; (ii) changes in the Company's billing and employee
utilization rates; (iii) the Company's ability to manage its growth effectively,
which will require the Company (a) to increase the number of its personnel,
particularly skilled technical, marketing and management personnel, (b) to find
suitable acquisition and joint venture candidates to support geographic
expansion, and (c) to continue to develop and improve its operational,
financial, communications and other internal systems, in the United States,
India and Europe; (iv) the Company's limited operating history with unaffiliated
customers; (v) the Company's reliance on key customers and large projects; (vi)
the highly competitive nature of the markets for the Company's services; (vii)
the Company's ability to successfully address the continuing changes in
information technology, evolving industry standards and changing customer
objectives and preferences; (viii) the Company's reliance on the continued
services of its key executive officers and leading technical personnel; (ix) the
Company's ability to attract and retain a sufficient number of highly skilled
employees in the future; (x) the Company's ability to protect its intellectual
property rights; (xi) the concentration of the Company's operations in India and
the related geo-political risks of local and cross-border conflicts; (xii)
terrorist activity, the threat of terrorist activity, and responses to and
results of terrorist activity and threats, including, but not limited to,
effects, domestically and/or internationally, on the Company, its personnel and
facilities, its customers and suppliers, financial markets and general economic
conditions; and (xiii) general economic conditions. Investors should also
consider the risks described in the Company's filings including the risk factors
contained in the Company's registration statement included as exhibit 99.2 to
this Quarterly Report. The Company's actual results may differ materially from
the results disclosed in such forward-looking statements.
-14-
RESULTS OF OPERATIONS
The following table sets forth certain results of operations as a
percentage of total revenue:
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
2002 2001 2002 2001
------ ------ ------ ------
Total revenues ......................... 100.0% 100.0% 100.0% 100.0%
Cost of revenues ....................... 53.8 50.8 53.4 51.3
------ ------ ------ ------
Gross profit ....................... 46.2 49.2 46.6 48.7
Selling, general and administrative
expense ............................ 23.1 25.1 23.4 25.5
Depreciation and amortization expense .. 3.3 3.6 3.5 3.4
------ ------ ------ ------
Income from operations ............. 19.8 20.5 19.7 19.8
Other income (expense):
Interest income .................... 0.8 1.4 0.8 1.5
Other income (expense) ............. 0.0 (0.5) (0.0) (0.5)
------ ------ ------ ------
Total other income ..................... 0.8 0.9 0.8 1.0
------ ------ ------ ------
Income before provision for income taxes 20.6 21.4 20.5 20.8
Provision for income taxes ............. (4.8) (8.0) (4.8) (7.8)
------ ------ ------ ------
Net income ............................. 15.8% 13.4% 15.7% 13.0%
====== ====== ====== ======
THREE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 2001
Revenue. Revenue increased by 34.6%, or $15.7 million, from approximately
$45.5 million during the three months ended September 30, 2001 to approximately
$61.2 million during the three months ended September 30, 2002. This increase
resulted primarily from an increase in application management services. For
statement of operations purposes, revenues from related parties include only
revenues recognized during the period in which the related party was directly
affiliated with the Company. In the third quarter of 2002, sales to one related
party customer (IMS Health) accounted for 9.0% of revenues and sales to one
third party customer (Metropolitan Life Insurance Company) accounted 11.5%
revenues. In the third quarter of 2001, sales to one related party customer (IMS
Health) accounted for 11.2% of revenues and no third-party customer accounted
for sales in excess of 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. The Company's cost of revenues
increased by 42.7%, or approximately $9.9 million, from approximately $23.1
million during the three months ended September 30, 2001 to approximately $33.0
million during the three months ended September 30, 2002. The increase was due
primarily to costs resulting from an increase in the number of the Company's
technical professionals from approximately 3,500 employees at September 30, 2001
to approximately 4,700 employees at September 30, 2002. The increased number of
the Company's technical professionals is a direct result of greater demand for
the Company's services. The Company's gross profit increased by 26.2%, or
approximately $5.9 million, from approximately $22.4 million during the three
months ended September 30, 2001 to approximately $28.3 million during the three
months ended September 30, 2002. Gross profit margin decreased from 49.2% of
revenues during the three months ended September 30, 2001 to 46.2% of revenues
during the three months ended September 30, 2002 primarily due to a higher 2002
incentive compensation accrual associated with increased revenues.
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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 as well as depreciation and amortization expense. Selling,
general and administrative expenses, including depreciation and amortization,
increased by 23.6%, or approximately $3.1 million, from approximately $13.1
million during the three months ended September 30, 2001 to approximately $16.2
million during the three months ended September 30, 2002, representing 28.7% and
26.4% of revenues, respectively. The dollar increase in such expenses was due
primarily to a higher 2002 incentive compensation accrual associated with
increased revenues, as well as increased expenses incurred to expand the
Company's sales and marketing activities and increased infrastructure expenses
to support the Company's revenue growth. The decrease in such expenses as a
percentage of revenue resulted from the Company's increased volume of revenue,
which outpaced the increase in selling, general and administrative expenses.
Income from Operations. Income from operations increased 29.9%, or
approximately $2.8 million, from approximately $9.3 million during the three
months ended September 30, 2001 to approximately $12.1 million during the three
months ended September 30, 2002, representing 20.5% and 19.8% of revenues,
respectively. The decrease in operating margin was due primarily to a higher
2002 incentive compensation accrual associated with increased revenues.
Other Income. Other income consists primarily of interest income and
foreign currency exchange gains or losses. Interest income decreased by 26.7%,
or approximately $172,000, from $643,000 during the three months ended September
30, 2001 to $471,000 during the three months ended September 30, 2002. The
decrease in such interest income was attributable primarily to declining
interest rates, offset, in part, by higher invested cash balances. The Company
recognized a net foreign currency exchange loss of $209,000 during the three
months ended September 30, 2001 as compared to a gain of $24,000 in the current
period, as a result of the effect of changing exchange rates.
Provision for Income Taxes. The provision for income taxes decreased by
19.5%, or approximately $713,000, from approximately $3.6 million in the three
months ended September 30, 2001 to approximately $2.9 million in the three
months ended September 30, 2002, with an effective tax rate of 37.4% and 23.3%
for the three months ended September 30, 2001 and 2002, respectively. The lower
effective tax rate reflects the Company'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 5 to the Notes to the Unaudited Condensed Consolidated Financial
Statements.)
Net Income. Net income increased 58.3%, or approximately $3.6 million,
from approximately $6.1 million for the three months ended September 30, 2001 to
approximately $9.7 million for the three months ended September 30, 2002,
representing 13.4% and 15.8% of revenues, respectively.
NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2001
Revenue. Revenue increased by 20.7%, or approximately $27.8 million, from
approximately $134.3 million during the nine months ended September 30, 2001 to
approximately $162.1 million during the nine months ended September 30, 2002.
This increase resulted primarily from an increase in application management
services. For statement of operations purposes, revenues from related parties
include only revenues recognized during the period in which the related party
was directly affiliated with the Company. During the nine months ended September
30, 2002, sales to one related party customer (IMS Health) accounted for 9.6% of
revenues and no third party accounted for sales in excess of 10% of revenues.
During the nine months ended September 30, 2001, sales to one related party
customer (IMS Health) accounted for 10.1% of revenues and no third party
accounted for sales in excess of 10% of revenues.
Gross Profit. The Company's cost of revenues increased by 25.6%, or
approximately $17.6 million, from approximately $68.9 million during the nine
months ended September 30, 2001 to approximately $86.5 million during the nine
months ended September 30, 2002. The increase was due primarily to increased
costs resulting from the increase in the number of the Company's technical
professionals from approximately 3,500 employees at
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September 30, 2001 to approximately 4,700 employees at September 30, 2002. The
Company's gross profit increased by 15.4%, or approximately $10.1 million, from
approximately $65.5 million during the nine months ended September 30, 2001 to
approximately $75.6 million during the nine months ended September 30, 2002.
Gross profit margin decreased from 48.7% to 46.6% of revenues during the nine
months ended September 30, 2001 and 2002, respectively. The decrease in gross
profit margin was due primarily to a higher 2002 incentive compensation accrual
associated with increased revenues.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses, including depreciation and amortization, increased by
12.2%, or approximately $4.7 million, from approximately $38.9 million during
the nine months ended September 30, 2001 to approximately $43.6 million during
the nine months ended September 30, 2002, representing 28.9% and 26.9% of
revenues, respectively. The increase in such expenses in absolute dollars was
due primarily to a higher 2002 incentive compensation accrual associated with
increased revenues, as well as expenses incurred to expand the Company's sales
and marketing activities and increased infrastructure expenses to support the
Company's revenue growth. The decrease in such expenses as a percentage of
revenue resulted from the Company's increased volume of revenue, which outpaced
the increase in selling, general and administrative expenses.
Income from Operations. Income from operations increased 20.2%, or
approximately $5.4 million, from approximately $26.6 million during the nine
months ended September 30, 2001 to approximately $32.0 million during the nine
months ended September 30, 2002, representing 19.8% and 19.7% of revenues,
respectively.
Other Income. Interest income decreased by $701,000 from approximately
$2.0 million during the nine months ended September 30, 2001 to approximately
$1.3 million during the nine months ended September 30, 2002. The decrease in
such interest income was attributable primarily to declining interest rates,
offset, in part, by higher invested cash balances. The Company recognized a net
foreign currency exchange loss of $604,000 during the nine months ended
September 30, 2001 compared to a loss of $89,000 in the current period, as a
result of changes in exchange rates.
Provision for Income Taxes. The provision for income taxes decreased from
approximately $10.5 million for the nine months ended September 30, 2001 to
approximately $7.7 million for the nine months ended September 30, 2002, with an
effective tax rate of 37.4% and 23.4% for the nine months ended September 30,
2001 and 2002, respectively. The lower effective tax rate reflects the Company's
change in its strategy 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 5 to the Notes to the
Unaudited Condensed Consolidated Financial Statements.)
Net Income. Net income increased from approximately $17.5 million for the
nine months ended September 30, 2001 to approximately $25.4 million for the nine
months ended September 30, 2002, representing 13.0% and 15.7% of revenues for
the nine months ended September 30, 2001 and 2002, respectively.
RESULTS BY BUSINESS SEGMENT
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. The Company's core competencies include
web-centric applications, data warehousing, component-based development and
legacy and client-server systems. The Company provides the IT services it offers
using an integrated on-site/offshore business model. This seamless
on-site/offshore 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. North American operations consist primarily of
application design, development and maintenance services in the United States
and Canada. European operations consist of application design, development and
maintenance services principally in the United Kingdom. Asian operations consist
of application design, development and maintenance 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
-17-
segmentation. Revenues and resulting operating income are attributed to regions
based upon customer location, and exclude the effect of intercompany revenue for
services provided by CTS India to other CTS entities.
THREE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 2001
North American Segment
Revenue. Revenue increased by 34.2%, or approximately $13.5 million, from
approximately $39.4 million for the three months ended September 30, 2001 to
approximately $52.9 million during the three months ended September 30, 2002.
The increase in revenue was attributable primarily to increased market awareness
and acceptance of the on-site/offshore application design, development and
maintenance services 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 29.5%, or
approximately $2.4 million, from approximately $8.1 million for the three months
ended September 30, 2001 to approximately $10.5 million for the three months
ended September 30, 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 41.8%, or approximately $2.4 million, from
approximately $5.7 million for the three months ended September 30, 2001 to
approximately $8.0 million for the three months ended September 30, 2002. The
increase in revenue was primarily attributable to increased demand for the
Company's services in the United Kingdom.
Income from Operations. Income from operations increased 36.8%, or
approximately $427,000, from approximately $1.2 million for the three months
ended September 30, 2001 to $1.6 million for the three months ended September
30, 2002. The increase in income from operations from the prior period was due
to expense reductions during the third quarter of 2002 coupled with increased
revenues.
Asian Segment
Revenue. Revenue decreased by 28.9%, or approximately $117,000, from
approximately $405,000 for the three months ended September 30, 2001 to
approximately $288,000 for the three months ended September 30, 2002.
Income from Operations. Income from operations was approximately $100,000
for each of the three months ended September 30, 2001 and 2002.
-18-
NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2001
North American Segment
Revenue. Revenue increased by 21.1%, or approximately $24.5 million, from
approximately $116.0 million for the nine months ended September 30, 2001 to
approximately $140.5 million for the nine months ended September 30, 2002. The
increase in revenue was attributable primarily to increased market awareness and
acceptance of the on-site/offshore application design, development and
application maintenance services 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 20.6%, or
approximately $4.7 million, from approximately $23.0 million for the nine months
ended September 30, 2001 to approximately $27.7 million for the nine months
ended September 30, 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 18.6%, or approximately $3.2 million, from
approximately $17.2 million for the nine months ended September 30, 2001 to
approximately $20.4 million for the nine months ended September 30, 2002. The
increase in revenue was primarily attributable to increased demand for the
Company's services in the United Kingdom.
Income from Operations. Income from operations increased by 18.2%, or
approximately $618,000, from approximately $3.4 million for the nine months
ended September 30, 2001 to $4.0 million for the nine months ended September 30,
2002. The increase in income from operations from the prior period was due to
expense reductions during 2002 coupled with increased revenues.
Asian Segment
Revenue. Revenue increased by 9.5%, or approximately $107,000, from
approximately $1.1 million for the nine months ended September 30, 2001 to
approximately $1.2 million for the nine months ended September 30, 2002.
Income from Operations. Income from operations was approximately $200,000
for each of the three months ended September 30, 2001 and 2002.
LIQUIDITY AND CAPITAL RESOURCES
Historically, through the date of its initial public offering, the
Company's primary sources of funding had been cash flow from operations and
intercompany cash transfers with its majority owner and controlling parent
company Cognizant Corporation and then IMS Health. In June 1998, the Company
consummated its initial public offering of 5,834,000 shares of its Class A
common stock at a price to the public of $5.00 per share, of which 5,000,000
shares were issued and sold by the Company and 834,000 shares were sold, at that
time, by Cognizant Corporation, the Company's then owner and controlling parent
company. The net proceeds to the Company from the offering were approximately
$22.4 million after $845,000 of direct expenses. The funds received by the
Company from the offering were invested in short-term, investment grade,
interest-bearing securities, after the Company used a portion of the net
proceeds to repay approximately $6.6 million of non-trade related party balances
to Cognizant Corporation. The Company has used and will continue to use the
remainder of the net proceeds from the offering for (i) expansion of existing
operations, including the Company's offshore IT development centers; (ii)
continued development of new service lines and possible acquisitions of related
businesses; and (iii) general corporate purposes including working capital. At
September 30, 2002, the Company had cash and cash equivalents of approximately
$123.1 million.
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Net cash provided by operating activities was approximately $35.6 million
during the nine months ended September 30, 2002 as compared to net cash provided
by operating activities of approximately $23.7 million during the nine months
ended September 30, 2001. The increase resulted primarily from increased net
income and an increase in accrued and other liabilities, partially offset by an
increase in trade accounts receivable.
Trade accounts receivable, net of allowance for doubtful accounts was
$30.2 million at September 30, 2002. The Company monitors turnover, aging and
the collection of accounts receivable through the use of management reports
which are prepared on a customer and geographic basis and evaluated by the
Company's finance staff. At September 30, 2002, the Company's day's sales
outstanding, including unbilled receivables, was approximately 59 days compared
to 55 days at September 30, 2001.
The Company's investing activities used net cash of approximately $10.3
million for the nine months ended September 30, 2002 as compared to net cash
used of approximately $10.7 million for the same period in 2001. The decrease in
2002 compared to 2001 primarily reflects a decrease in purchases of property and
equipment partially offset by the acquisition of certain assets from
UnitedHealthcare Ireland Ltd. (See Note 2 to the Notes to the Unaudited
Condensed Consolidated Financial Statements).
The Company's financing activities provided net cash of approximately
$13.0 million for the nine months ended September 30, 2002 as compared to net
cash provided by financing activities of approximately $4.8 million for the same
period in 2001. The increase in net cash provided by financing activities was
related primarily to a higher level of cash proceeds from the exercise of stock
options and the purchase of employee stock purchase plan shares in 2002, as
compared to the prior year. The exercise of stock options and the purchase of
employee stock purchase plan shares resulted in an increase of approximately
680,000 shares in the Company's outstanding Class A Common Stock during the nine
months ended September 30, 2002.
As of September 30, 2002, the Company had no significant third-party debt.
The Company had working capital of $136.6 million at September 30, 2002
and $95.6 million at December 31, 2001.
As of September 30, 2002, the Company has entered into fixed capital
commitments related to its India development center expansion program of
approximately $20.1 million, of which $10.9 million has been spent to date. The
multi-phase program will encompass the construction of three fully-owned
development centers containing approximately 620,000 sq. ft. of space in the
Indian cities of Calcutta, Chennai and Pune. Total expenditures related to this
program are expected to be approximately $39.4 million. The Company has recently
completed construction of the two facilities in Calcutta and Pune, and expects
construction of the third development center in Chennai to be completed in 2003.
The Company expects to incur charges in the fourth quarter of 2002 and the
first quarter of 2003 aggregating between $2 to $3 million in relation to
one-time costs associated with the Exchange Offer.
The Company believes that its available funds and the cash flows expected
to be generated from operations, will be adequate to satisfy its current and
planned operations and needs through at least the next 12 months.
FOREIGN CURRENCY TRANSLATION
The assets and liabilities of the Company's Canadian and European
subsidiaries are translated into U.S. dollars at current exchange rates and
revenues and expenses are translated at average monthly exchange rates. The
resulting translation adjustments are recorded in a separate component of
stockholders' equity. For the Company's Indian subsidiary, 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 the
Indian subsidiary 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. A portion of
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the Company's costs in India is denominated in local currency and subject to
exchange fluctuations, which has not had any material adverse effect on the
Company's results of operations.
CONTINGENCIES
As of September 30, 2002, the Company has entered into fixed capital
commitments related to its India development center expansion program of
approximately $20,109, of which approximately $10,924 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' business 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 application design, 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 or co-insurance
requirements, could have a material adverse effect on the Company's business,
results of operations and financial condition.
EFFECTS OF INFLATION
The Company's most significant costs are the salaries and related benefits
for its programming staff and other professionals. Competition in India and the
United States for professionals with advanced technical skills necessary to
perform the services offered by the Company have caused wages to increase at a
rate greater than the general rate of inflation. As with other IT service
providers, the Company must adequately anticipate wage increases, particularly
on its fixed-price contracts. There can be no assurance that the Company will be
able to recover cost increases through increases in the prices that it charges
for its services in the United States and elsewhere.
RECENT ACCOUNTING PRONOUNCEMENTS
Statements of Financial Accounting Standards Adopted:
In June 2001, Statement of Financial Accounting Standards No. 141,
"Business Combinations" ("FAS 141") and Statement of Financial Accounting
Standards No. 142 "Goodwill and Other Intangible Assets" ("FAS 142") were
issued. FAS 141 requires the purchase method of accounting to be used for all
business combinations initiated after June 30, 2001. FAS 141 also specifies
criteria that intangible assets acquired must meet to be recognized and reported
separately from goodwill. FAS 142 requires that goodwill and intangible assets
with indefinite lives no longer be amortized but instead be measured for
impairment at least annually, or when events indicate that there may be an
impairment. FAS 142 is effective for fiscal years beginning after December 15,
2001. The adoption of FAS 141 and FAS 142 did not have a material effect on the
Company's financial position or results of operations. The following table sets
forth the Company's results had FAS 142 been applied to the prior-period
financial statements presented herein.
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THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, 2001 SEPTEMBER 30, 2001
------------------ ------------------
Reported Net Income $ 6,108 $17,520
Reversal of Goodwill Amortization - net of tax 79 238
------- -------
Adjusted Net Income excluding Goodwill Amortization $ 6,187 $17,758
Adjusted Basic EPS excluding Goodwill Amortization $ 0.32 $ 0.94
Adjusted Diluted EPS excluding Goodwill Amortization $ 0.30 $ 0.87
In August 2001, Statement of Financial Accounting Standards No. 144,
"Accounting for the Impairment or Disposal of Long-lived Assets" ("FAS 144") was
issued. FAS 144 supersedes Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-lived Assets to be Disposed of," and the
accounting and reporting provisions of Accounting Principles Board Opinion No.
30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a
Segment of a Business, and Extraordinary, Unusual and Infrequently occurring
Events and Transactions." FAS 144 also amends Accounting Research Bulletin No.
51, Consolidated Financial Statements, to eliminate the exception to
consolidation for a subsidiary for which control is likely to be temporary. FAS
144 retains the fundamental provisions of FAS 121 for recognizing and measuring
impairment losses on long-lived assets held for use and long-lived assets to be
disposed of by sale, while resolving significant implementation issues
associated with FAS 121. Among other things, FAS 144 provides guidance on how
long-lived assets used as part of a group should be evaluated for impairment,
establishes criteria for when long-lived assets are held for sale, and
prescribes the accounting for long-lived assets that will be disposed of other
than by sale. FAS 144 is effective for fiscal years beginning after December 15,
2001. The adoption of FAS 144 did not have a material impact on the Company's
financial position and results of operations.
In April 2002, Statement of Financial Accounting Standards No. 145,
"Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement
No. 13, and Technical Corrections" ("FAS 145") was issued. FAS 145 updates,
clarifies and simplifies existing accounting pronouncements and is generally
effective for transactions occurring after May 15, 2002. The adoption of this
statement did not have a material impact on the Company's financial position or
results of operations.
Statements of Financial Accounting Standards Not Yet Adopted:
In June 2001, Statement of Financial Accounting Standards No. 143,
"Accounting for Asset Retirement Obligations" ("FAS 143") was issued. FAS 143
addresses financial accounting and reporting for legal obligations associated
with the retirement of tangible long-lived assets and the associated retirement
costs that result from the acquisition, construction, or development and normal
operation of a long-lived asset. Upon initial recognition of a liability for an
asset retirement obligation, FAS 143 requires an increase in the carrying amount
of the related long-lived asset. The asset retirement cost is subsequently
allocated to expense using a systematic and rational method over the asset's
useful life. FAS 143 is effective for fiscal years beginning after June 15,
2002. The adoption of this statement is not expected to have a material impact
on the Company's financial position or results of operations.
In June 2002, Statement of Financial Accounting Standards No. 146,
"Accounting for Exit or Disposal Activities" ("FAS 146") was issued. FAS 146
addresses the accounting for costs to terminate a contract that is not a capital
lease, costs to consolidate facilities and relocate employees, and involuntary
termination benefits under one-time benefit arrangements that are not an ongoing
benefit program or an individual deferred compensation contract. A liability for
contract termination costs should be recognized and measured at fair value
either when the contract is terminated or when the entity ceases to use the
right conveyed by the contract. A liability for one-time termination benefits
should be recognized and measured at fair value at the communication date if the
employee would not be retained beyond a minimum retention period (i.e., either a
legal notification period or 60 days, if no legal requirement exists). For
employees that will be retained beyond the minimum retention period, a liability
should be accrued ratably over the future service period. The provisions of the
statement will be effective for disposal activities initiated after December 31,
2002. The adoption of this statement is not expected to have a material impact
on the Company's financial position or results of operations.
-22-
In October 2002, Statement of Financial Accounting Standards No. 147,
"Acquisitions of Certain Financial Institutions" ("FAS 147") was issued. FAS 147
addresses the financial accounting and reporting for the acquisition of all or
part of a financial institution, except for a transaction between two or more
mutual enterprises. FAS 147 also provides guidance on the accounting for the
impairment or disposal of acquired long-term customer-relationship intangible
assets, including those acquired in transactions between two or more mutual
enterprises. The provisions of the statement will be effective for acquisitions
for which the date of acquisition is on or after October 1, 2002. The adoption
of this statement is not expected to have a material impact on the Company's
financial position or results of operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not applicable.
ITEM 4. CONTROLS AND PROCEDURES.
Evaluation of disclosure controls and procedures. Based on their
evaluation of the Company's disclosure controls and procedures (as defined in
Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934) as of a
date within 90 days of the filing date of this Quarterly Report on Form 10-Q,
the Company's chief executive officer and chief financial officer have concluded
that the Company's disclosure controls and procedures are designed to ensure
that information required to be disclosed by the Company in the reports that it
files or submits under the Securities Exchange Act of 1934 is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission's rules and forms and are operating in an
effective manner.
Changes in internal controls. There were no significant changes in the
Company's internal controls or in other factors that could significantly affect
these controls subsequent to the date of their most recent evaluation.
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PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
99.1 Statements Pursuant to 18 U.S.C.Section 1350.
99.2 Risk factor extract
(b) Reports on Form 8-K.
Subsequent to the end of the quarter, on October 31, 2002, the Company
filed a Form 8-K disclosing the transfer of Silverline Technologies, Inc.'s
American Express practice to the Company.
-24-
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.
Cognizant Technology Solutions Corporation
DATE: November 14, 2002 By /s/ Wijeyaraj Mahadeva
-------------------------------
Wijeyaraj Mahadeva,
Chairman of the Board and Chief
Executive Officer (Principal Executive
Officer)
DATE: November 14, 2002 By /s/ Gordon Coburn
-------------------------------
Gordon Coburn,
Chief Financial Officer and Treasurer
(Principal Financial and Accounting
Officer)
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CERTIFICATION
I, Wijeyaraj Mahadeva, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Cognizant
Technology Solutions Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented
in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries, is
made known to us by others within those entities,
particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date within
90 days prior to the filing date of this quarterly
report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and
procedures based on our evaluation as of the Evaluation
Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent function):
a) all significant deficiencies in the design or operation
of internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
-26-
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
/s/ Wijeyaraj Mahadeva
----------------------
Dated: November 14, 2002 Wijeyaraj Mahadeva
Chairman of the Board and Chief
Executive Officer (Principal Executive
Officer)
-27-
CERTIFICATION
I, Gordon Coburn, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Cognizant
Technology Solutions Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect
to the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented
in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries, is
made known to us by others within those entities,
particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date within
90 days prior to the filing date of this quarterly
report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and
procedures based on our evaluation as of the Evaluation
Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent function):
a) all significant deficiencies in the design or operation
of internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
-28-
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
/s/ Gordon Coburn
-----------------
Dated: November 14, 2002 Gordon Coburn,
Chief Financial Officer and Treasurer
(Principal Financial and Accounting
Officer)
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