SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------
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, 1998
Commission File No. 0-24429
Cognizant Technology Solutions Corporation
------------------------------------------
(Exact Name of Registrant as Specified in Its Charter)
Delaware 13-3728359
- ---------------------------- -----------------------------------
(State or OtherJurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
1700 Broadway, 26th Floor, New York, New York 10019
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(Address of Principal Executive Offices) (Zip Code)
(212) 887-2385
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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 the number of shares outstanding of each of the Registrant's
classes of common stock, as of October 31, 1998:
Class Number of Shares
----- ----------------
Class A Common Stock, par 3,505,411
value $.01 per share
Class B Common Stock, par 5,645,450
value $.01 per share
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
TABLE OF CONTENTS
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements.................... 1
Condensed Consolidated Statements of Financial Position
(unaudited) as of September 30, 1998 and
December 31, 1997 ............................................. 2
Condensed Consolidated Statements of Income
for the Three Months and Nine Months Ended
September 30, 1998 and 1997 (unaudited)........................ 3
Condensed Consolidated Statements of Cash Flows for the Nine
Months Ended September 30, 1998 and 1997 (unaudited) .......... 4
Notes to Condensed Consolidated Financial Statements
(unaudited).................................................... 5
Item 2. Management's Discussion and Analysis of
Results of Operations and Financial Condition.................. 7
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K............................... 16
SIGNATURES.................................................................. 17
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PART I. FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
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COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
CONDENSED CONSOLIDATED STATEM ENTS OF FINANCIAL POSITION
As of September 30, 1998 and December 31, 1997
(dollars in thousands, except par values)
September 30, December 31,
1998 1997
------------ -----------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents.......................... $ 26,053 $ 2,715
Trade accounts receivable, net of allowances of
$227 and $239, respectively........................ 7,015 4,733
Trade accounts receivable-related party............ 1,463 2,670
Other current assets............................... 2,613 778
--------- ---------
Total current assets............................ 37,144 10,896
--------- ---------
Property and equipment, net of accumulated depreciation
of $3,905 and $2,542, respectively................. 5,490 4,453
Goodwill, net......................................... 1,909 2,147
Other assets.......................................... 153 802
--------- ---------
Total assets $ 44,696 $ 18,298
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................... $ 910 $ 1,543
Accrued and other current liabilities.............. 8,941 3,659
--------- ---------
Total current liabilities....................... 9,851 5,202
Deferred income taxes................................. 4,816 2,593
Due to related party.................................. 148 6,646
--------- ---------
Total liabilities............................... 14,815 14,441
--------- ---------
Commitments and Contingencies
Mandatorily redeemable common stock (113,750 shares
issued and outstanding at December 31, 1997,
none at September 30, 1998)........................ -- 438
--------- ---------
Stockholders' equity:
Preferred stock, $.10 par value, 15,000,000 shares
authorized, none issued............................ -- --
Class A common stock, $.01 par value, 100,000,000
shares authorized, 3,375,262 shares and 417,000
shares issued and outstanding at September 30,
1998 and December 31, 1997, respectively........... 34 4
Class B common stock, $.01 par value, 15,000,000
shares authorized, 5,645,450 and 6,083,000 shares
issued and outstanding at September 30, 1998 and
December 31, 1997, respectively................... 56 61
Additional paid-in-capital........................... 24,379 1,420
Retained earnings.................................... 5,414 1,936
Cumulative translation adjustment.................... (2) (2)
--------- ---------
Total stockholders' equity...................... 29,881 3,419
--------- ---------
Total liabilities and stockholders' equity...... $ 44,696 $ 18,298
========= =========
The accompanying notes are an integral part of the consolidated financial
statements.
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COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(in thousands, except per share data)
Three Months Ended Sept. 30, Nine Months Ended Sept. 30,
---------------------------- ---------------------------
1998 1997 1998 1997
--------- --------- --------- --------
Revenues....................... $13,559 $4,126 $28,581 $8,995
Revenues - related party....... 2,641 3,020 10,525 7,727
----- ----- ------ ------
Total revenues.............. 16,200 7,146 39,106 16,722
Cost of revenues............... 8,925 4,146 22,180 9,697
----- ----- ------ ------
Gross profit................... 7,275 3,000 16,926 7,025
Selling, general and
administrative expenses....... 4,254 2,093 10,184 5,021
Depreciation and amortization
expenses...................... 586 314 1,602 916
---- ----- ------ ------
Income from operations......... 2,435 593 5,140 1,088
Other income:
Interest income............. 254 2 334 5
Other income - net.......... 25 -- 82 --
---- ----- ----- ------
Total other income........ 279 2 416 5
---- ----- ----- ------
Income before provision for
income taxes................... 2,714 595 5,556 1,093
Provision for income taxes..... (1,014) (110) (2,079) (183)
Minority interest.............. -- (271) -- (545)
---- ----- ----- ------
Net income..................... $ 1,700 $ 214 $ 3,477 $ 365
======= ====== ======= ======
Basic earnings per share....... $ 0.19 $ 0.03 $ 0.46 $ 0.06
======= ====== ======= ======
Diluted earnings per share..... $ 0.18 $ 0.03 $ 0.44 $ 0.06
======= ====== ======= ======
Weighted average number of
common shares outstanding..... 9,121 6,547 7,566 6,528
======= ====== ======= ======
Weighted average number of
common shares and stock
options outstanding........... 9,417 6,605 7,820 6,545
======= ====== ======= ======
The accompanying notes are an integral part of the 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
-------------------------
Sept. 30, Sept. 30,
1998 1997
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Cash flows from operating activities:
Net income.............................................. $ 3,477 $ 365
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization..................... 1,602 916
Provision for doubtful accounts................... 39 --
Deferred income taxes............................. 2,223 569
Minority interest................................. -- 545
Changes in assets and liabilities:
Accounts receivable............................... (1,114) (3,178)
Other current assets.............................. (1,835) (1,261)
Other assets...................................... 649 444
Accounts payable.................................. (633) 2,039
Accrued and other liabilities..................... 5,430 545
--------- ---------
Net cash provided by operating activities............... 9,838 984
--------- ---------
Cash flows from investing activities:
Purchase of property and equipment...................... (2,400) (2,072)
------- -------
Net cash used in investing activities................... (2,400) (2,072)
------- -------
Cash flows from financing activities:
Proceeds from issued shares/contributed capital, net.... 22,546 (248)
Payments to / proceeds from related party............... (6,646) 1,661
-------- -------
Net cash provided by financing activities............... 15,900 1,413
-------- -------
Increase in cash and cash equivalents .................. 23,338 325
Cash and cash equivalents, beginning of year............ 2,715 1,810
--------- -------
Cash and cash equivalents, end of period.......... $26,053 $ 2,135
======= =======
Supplemental disclosures of cash flow information:
Cash paid during the period for interest............. $ -- $ --
Cash paid during the period for income taxes......... $ 2 $ 19
The accompanying notes are an integral part of the consolidated financial
statements.
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COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
NOTES TO CONDENSED CONSOLI DATED 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
(the "Company") in accordance with generally accepted accounting principles and
Article 10 of Regulation S-X under the Securities and Exchange Act of 1934, as
amended. The condensed consolidated financial statements and related notes as of
September 30, 1998, December 31, 1997 and for the three and nine month periods
ended September 30, 1998 and 1997 should be read in conjunction with the
Company's consolidated financial statements (and notes thereto) included in the
Company's filing on Form S-1 (Registration No. 333-49783). Accordingly, the
accompanying condensed consolidated financial statements do not include all the
information and notes required by generally accepted accounting principles for
complete financial statements. In the opinion of the Company's management, all
adjustments considered necessary for a fair presentation of the accompanying
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 the results that may be
expected to occur for the entire year.
NOTE 2 - COMPREHENSIVE INCOME:
The Company has adopted SFAS No. 130, "Reporting Comprehensive Income,"
which requires presentation of information on comprehensive income and its
components in the financial statements. For the Company, comprehensive income
includes net income and foreign currency translation adjustments. Total
comprehensive income and its components for the three months ended September 30,
1998 and 1997 and the nine months ended September 30, 1998 and 1997 are as
follows:
Three Months Ended Sept. 30, Nine Months Ended Sept.30,
---------------------------- --------------------------
1998 1997 1998 1997
---- ---- ---- ----
Net income................ $ 1,700 $ 215 $ 3,477 $ 365
Foreign currency
translation adjustment.... 2 -- 1 --
------- ---- ------- ------
Total comprehensive
income.................... $1,702 $ 215 $ 3,478 $ 365
====== ====== ======= ======
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
NOTE 3 - INITIAL PUBLIC OFFERING:
On June 24, 1998, the Company consummated its Initial Public Offering
("IPO") of 2,917,000 shares of its Common Stock at a price of $10.00 per share,
2,500,000 of which were issued and sold by the Company and 417,000 of which were
sold by IMS Health Incorporated ("IMS HEALTH"), the "accounting successor" to
Cognizant Corporation ("Cognizant"), the Company's parent company. The net
proceeds to the Company from the IPO were approximately $22.4 million after
$845,000 of direct expenses.
Of the total net proceeds received by the Company upon the consummation of
its Initial Public Offering, approximately $6.6 million was used to repay the
related party balance owed to Cognizant. The related party balance resulted from
certain advances to the Company from Cognizant used to purchase the minority
interest of the Company's Indian subsidiary and to fund payroll and accounts
payable. Concurrent with the IPO, the Company reclassified the amounts in
mandatorily redeemable common stock to stockholders' equity as the redemption
feature was void.
NOTE 4 - RELATED PARTY TRANSACTIONS:
In July 1998, IMS HEALTH sold 437,550 shares of Class B Common Stock. After
such sale, IMS HEALTH owned approximately 61.9% of the outstanding Common Stock
of the Company and held approximately 94.2% of the combined voting power of the
Company's Common Stock.
IMS HEALTH currently provides the Company with certain administrative
services including payroll and payables processing, e-mail, tax planning and
compliance, and permits the Company to participate in IMS HEALTH's insurance and
employee benefit plans. Costs for these services are allocated to the Company
based on utilization of certain specific services. Management believes that such
amounts are lower than the aggregate amounts the Company would have paid for the
services had the Company obtained the services from unrelated parties.
NOTE 5 - ADOPTION OF STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS:
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities". SFAS No. 133 establishes accounting and
reporting standards for derivative instruments embedded in other contracts,
(collectively referred to as derivatives) and for hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. If certain conditions are met, a derivative may be specifically
designated as (a) a hedge of the exposure to changes in the fair value of a
recognized asset or liability or an unrecognized firm commitment, (b) a hedge of
the exposure to variability in cash flows attributable to a particular risk, or
(c) a hedge of the foreign currency exposure of a net investment in a foreign
operation, an unrecognized firm commitment, an available for sale security and a
forecasted transaction. The Company will be required to implement SFAS No. 133
for all fiscal quarters of fiscal years
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beginning after June 15, 1999. The Company expects the adoption of this
pronouncement will not have a material effect on the Company's financial
statements.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION.
GENERAL
The Company delivers full life cycle software development and maintenance
services to its customers through the use of a seamless on-site and offshore
project team. These services include application development and maintenance
services, Year 2000 and Eurocurrency compliance services, testing and quality
assurance services and re-hosting and re-engineering services.
The Company began its software 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, Erisco,
Inc. ("Erisco"), IMS International Inc. ("IMS"), Nielsen Media Research, Inc.,
Pilot Software Inc. and Sales Technologies, Inc. and certain other entities,
plus a majority interest in Gartner Group, Inc. were spun-off from The Dun &
Bradstreet Corporation to form Cognizant. In 1997, the Company purchased the
24.0% minority interest in its Indian subsidiary from a third party for $3.4
million, making the Indian subsidiary wholly owned by the Company. In June 1998,
the Company completed its IPO. On June 30, 1998, a majority interest in the
Company, Erisco, IMS and certain other entities were spun-off from Cognizant to
form IMS HEALTH.
The Company's services are performed on either a time-and-materials or
fixed-price basis. The Company expects that an increasing number of its future
projects will be fixed-price rather than time-and-materials (which has
historically been the basis for its contracts). Revenues related to
time-and-materials contracts are recognized as the service is performed.
Revenues related to 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 cost to date bears to the total estimated cost.
Estimates are subject to adjustment as a project progresses to reflect changes
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. Since the Company bears the risk
of cost over-runs and inflation associated with fixed-price projects, the
Company's operating results may be adversely affected by changes in estimates of
contract completion costs and dates.
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 of forward-looking terminology
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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 software 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, and (f) 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, and (b) to continue to develop and improve its
operational, financial, communications and other internal systems, both in the
United States and India; (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) general economic conditions; (xii) year
2000 compliance of vendors' products and related issues, including impact of the
year 2000 problem on customer buying patterns, and (xiii) the outcome of the
impact of year 2000. The Company's actual results may differ materially from the
results disclosed in such forward-looking statements.
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RESULTS OF OPERATIONS
The following table sets forth certain results of operations as a
percentage of total revenue:
Three Months Ended Sept. 30, Nine Months Ended Sept 30,
---------------------------- --------------------------
1998 1997 1998 1997
---- ---- ---- ----
Total revenues................ 100.0% 100.0% 100.0% 100.0%
Cost of revenues.............. 55.1 58.0 56.7 58.0
----- ----- ----- -----
Gross profit............... 44.9 42.0 43.3 42.0
Selling, general and
administrative expenses....... 26.3 29.3 26.0 30.0
Depreciation and amortization
expense....................... 3.6 4.4 4.1 5.5
----- ----- ----- -----
Income from operations..... 15.0 8.3 13.1 6.5
Other income (expense):
Interest income............ 1.6 -- 0.9 --
Other income (expense)..... 0.2 -- 0.2 --
----- ----- ----- -----
Total other income (expense).. 1.8 -- 1.1 --
----- ----- ----- -----
Income before provision for
income taxes............... 16.8 8.3 14.2 6.5
Provision for income taxes.... (6.3) (1.5) (5.3) (1.1)
Minority interest............. -- (3.8) -- (3.2)
----- ----- ----- -----
Net income ................... 10.5% 3.0% 8.9% 2.2%
===== ===== ===== =====
THREE MONTHS ENDED SEPT. 30, 1998 COMPARED TO THREE MONTHS ENDED SEPT. 30, 1997
Revenue. Revenue increased by 126.7%, or $9.1 million, from $7.1 million
during the three months ended September 30, 1997 to $16.2 million during the
three months ended September 30, 1998. This increase included $4.5 million of
increased Year 2000 compliance services, and $4.5 million of increased sales of
software development, maintenance and Eurocurrency compliance services. The
percentage of revenues from unrelated parties increased from 57.7% during the
three months ended September 30, 1997 to 83.7% during the three months ended
September 30, 1998. This increase resulted primarily from the Company's
continued efforts to pursue unaffiliated third-party customers and the impact of
the spin-off in June 1998 of a majority interest in the Company, Erisco, IMS and
certain other entities to form IMS HEALTH. For statement of operations purposes,
revenues from related parties only include revenues recognized during the period
in which the related party was affiliated with the Company.
Gross profit. The Company's cost of revenues consists primarily of the cost
of salaries, payroll taxes, benefits, immigration and travel for technical
personnel, and the cost of sales commissions related to revenues. The Company's
cost of revenues increased by 115.3%, or $4.8 million, from $4.1 million during
the three months ended September 30, 1997 to $8.9 million during the three
months ended September 30, 1998. The increase was due primarily to the increased
cost resulting from the increase in the number of the Company's technical
professionals from approximately 835 employees at September 30, 1997 to
approximately 1,300
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employees at September 30, 1998. The Company's gross profit increased by 142.5%,
or approximately $4.3 million, from approximately $3.0 million during the three
months ended September 30, 1997 to approximately $7.3 million during the three
months ended September 30, 1998. Gross profit margin increased from 42.0% of
revenues during the three months ended September 30, 1997 to 44.9% of revenues
during the three months ended September 30, 1998. The increase in such gross
profit margin was primarily attributable to the increased third party revenue
which have higher margins and a higher utilization level of technical
professionals during the three months ended September 30, 1998 compared to the
three months ended September 30, 1997.
Selling, general and administrative expenses. Selling, general and
administrative expenses consist primarily of salaries, employee benefits,
travel, promotion, communications, management, finance, administrative and
occupancy costs. Selling, general and administrative expenses, including
depreciation and amortization, increased by 101.1%, or $2.4 million, from $2.4
million during the three months ended September 30, 1997 to $4.8 million during
the three months ended September 30, 1998, but decreased as a percentage of
revenue from 33.7% to 29.9%. The increase in such expenses in absolute dollars
was primarily due to expenses incurred to expand the Company's sales and
marketing activities and increased infrastructure expenses to support the
Company's revenue growth. The Company expects selling, general and
administrative expenses to continue to increase in absolute dollars to support
the Company's expansion. The decrease in selling, general and administrative
expenses as a percentage of revenue resulted from the Company's dramatically
increased volume of revenue.
Income from Operations. Income from operations increased 310.6% or $1.8
million, from $593,000 during the three months ended September 30 1997 to $2.4
million during the three months ended September 30, 1998, representing 8.3% and
15.0% of revenues, respectively. The increase in operating margin was primarily
due to the increased third-party revenue which generally has higher margins and
the higher utilization level of technical professionals mentioned above.
Other Income. Other income consists primarily of interest income and
foreign currency exchange gains. Interest income increased by $252,000 from
$2,000 during the three months ended September 30 1997 to $254,000 during the
three months ended September 30, 1998. The increase in such interest income was
attributable primarily to increased interest income resulting from the
investment of the net proceeds generated from the Company's IPO and generally
higher cash balances. The Company recognized a net foreign currency exchange
gain of $25,000 during the three months ended September 30, 1998, as a result of
the effect of changing exchange rates on the Company's transactions.
Provision for Income Taxes. Historically, the Company has been included in
the consolidated federal income tax returns of IMS HEALTH (formerly, The Dun &
Bradstreet Corporation and Cognizant). The Company's provision for income taxes
in the consolidated statements of income reflects federal and state income taxes
calculated on the Company's stand alone basis. The provision for income taxes
increased from $110,000 in the three months ended September 30, 1997 to $1.0
million in the three months ended September 30, 1998 resulting in
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an effective tax rate of 18.5% in 1997 and 37.4% in 1998. Without the effect of
minority interest, the effective tax rate would have been 34.0% in 1997.
Minority Interest. In the three months ended September 30, 1997, minority
interest expense was $271,000. This expense was attributable to profitability of
the Company's Indian subsidiary in which an unaffiliated third party held a
24.0% minority interest. The Company purchased the minority interest in October
1997 for $3.4 million. The Company has not recognized any minority expense
subsequent to such purchase. In the current period, the Company recorded $79,000
of amortization expense in connection with the goodwill recorded on the
acquisition of the remaining portion of its Indian subsidiary.
Net Income. Net income increased from $214,000 for the three months ended
September 30, 1997 to $1.7 million for the three months ended September 30,
1998, representing 3.0% and 10.5% as a percentage of revenues, respectively.
NINE MONTHS ENDED SEPT. 30, 1998 COMPARED TO NINE MONTHS ENDED SEPT. 30, 1997
Revenue. Revenue increased by 133.9%, or $22.4 million, from $16.7 million
during the nine months ended September 30, 1997 to $39.1 million during the nine
months ended September 30, 1998. This increase included $11.9 million of
increased Year 2000 compliance services, and $10.5 million of increased sales of
software development, maintenance and Eurocurrency compliance services. The
percentage of revenues from unrelated parties increased from 53.8% during the
nine months ended September 30, 1997 to 73.1% during the nine months ended
September 30, 1998. This increase resulted from the Company's continued efforts
to pursue unaffiliated third-party customers and the partial impact of the
spin-off in June 1998 of a majority interest in the Company, Erisco, IMS and
certain other entities to form IMS HEALTH.
Gross profit. The Company's cost of revenues increased by 128.7%, or $12.5
million, from $9.7 million during the nine months ended September 30, 1997 to
$22.2 million during the nine months ended September 30, 1998. The increase was
due primarily to the increased cost resulting from the increase in the number of
the Company's technical professionals from approximately 835 employees at
September 30, 1997 to approximately 1,300 employees at September 30, 1998. The
Company's gross profit increased by 140.9%, or approximately $9.9 million, from
approximately $7.0 million during the nine months ended September 30, 1997 to
approximately $16.9 million during the nine months ended September 30, 1998.
Gross profit margin increased from 42.0% of revenues during the nine months
ended September 30, 1997 to 43.3% of revenues during the nine months ended
September 30, 1998. The increase in such gross profit margin was primarily
attributable to the increased third party revenue which have higher margins and
a higher utilization level of technical professionals during the nine months
ended September 30, 1998 compared to the nine months ended September 30, 1997.
Selling, general and administrative expenses. Selling, general and
administrative expenses, including depreciation and amortization, increased by
98.5%, or $5.8 million, from $5.9 million during the nine months ended September
30, 1997 to $11.8 million during the nine months ended September 30, 1998, but
decreased as a percentage of revenue from 35.5% to
- 11 -
30.1% of revenue. The increase in such expenses in absolute dollars was due
primarily from 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 selling, general and administrative expenses as
a percentage of revenue resulted from the Company's dramatically increased
volume of revenue.
Income from Operations. Income from operations increased 372.4% or $4.1
million, from $1.1 million during the nine months ended September 30 1997 to
$5.1 million during the nine months ended September 30, 1998, representing 6.5%
and 13.1% of revenues, respectively. The increase in operating margin was
primarily due to the increased third-party revenue which generally has higher
margins and the higher utilization level of technical professionals mentioned
above.
Other Income. Other income consists primarily of interest income and
foreign currency exchange gains. Interest income increased by $329,000, from
$5,000 during the nine months ended September 30, 1997 to $334,000 during the
nine months ended September 30, 1998. The increase in such interest income was
attributable primarily to increased interest income resulting from the
investment of the net proceeds generated from the Company's IPO and generally
higher cash balances. The Company recognized a net foreign currency exchange
gain of $82,000 during the nine months ended September 30, 1998, as a result of
the effect of changing exchange rates on the Company's transactions.
Provision for Income Taxes. The provision for income taxes increased from
$183,000 in the nine months ended September 30, 1997 to $2.1 million in the nine
months ended September 30, 1998 resulting in an effective tax rate of 16.7% in
1997 and 37.4% in 1998. Without the effect of minority interest, the effective
tax rate would have been 33.4% in 1997.
Minority Interest. In the nine months ended September 30, 1997, minority
interest expense was $545,000. This expense was attributable to profitability of
the Company's Indian subsidiary in which an unaffiliated third party held a
24.0% minority interest. The Company purchased the minority interest in October
1997 for $3.4 million. The Company has not recognized any minority expense
subsequent to such purchase. For the nine month period, the Company recorded
$238,000 of amortization expense in connection with the goodwill recorded on the
acquisition of the remaining portion of its Indian subsidiary.
Net Income. Net income increased from $365,000 for the nine months ended
September 30, 1997 to $3.5 million for the nine months ended September 30, 1998,
representing 2.2% and 8.9% as a percentage of revenues, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company's primary sources of funding had been cash flow
from operations and intercompany cash transfers with IMS HEALTH. In June 1998,
the Company consummated its IPO of 2,917,000 shares of its Class A Common Stock
at a price to the public of $10.00 per share, of which 2,500,000 shares were
issued and sold by the Company and 417,000 shares were sold by a Selling
Stockholder. The net proceeds to the Company from the
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offering were approximately $22.4 million after $845,000 of direct expenses. The
funds received by the Company from the IPO were invested in short-term,
investment grade, interest bearing securities. The Company used a portion of the
net proceeds to repay approximately $6.6 million of non-trade related party
balances. The Company expects to use the remainder of the net proceeds from the
offering for (i) expansion of existing operations, including the Company's
offshore software development centers; (ii) continued development of new service
lines and possible acquisitions of related businesses; and (ii) general
corporate purposes including working capital.
Net cash provided by operating activities was approximately $9.8 million
during the nine months ended September 30, 1998 as compared to net cash provided
by operating activities of $984,000 during the nine months ended September 30,
1997. The increase results primarily from a higher level of accrued liabilities,
increased net income, and an increase in deferred taxes, partially offset by
increased accounts receivable and increased other current assets. Accounts
receivable increased from $7.4 million at December 31, 1997 to $8.5 million at
September 30, 1998. The increase in accounts receivable was due primarily to the
Company's increase in revenue partially offset by improved collection efforts
and results. The Company monitors turnover, aging and the collection of accounts
receivable through the use of management reports which are prepared on a
customer basis and evaluated by the Company's finance staff.
The Company's investing activities used net cash of $2.4 million for the
nine months ended September 30, 1998 as compared to net cash used of $2.1
million for the same period in 1997. The slight increase in 1998 compared to
1997 reflects the increased purchases of equipment to expand the Company's
offshore development infrastructure.
The Company's financing activities provided net cash of $15.9 million for
the nine months ended September 30, 1998 as compared to $1.4 million for the
same period in 1997. The increase in 1998 compared to 1997 resulted primarily
from the net proceeds generated from the IPO of $22.4 million, offset by the
repayment of the related party balance due to Cognizant of approximately $6.6
million.
As of September 30, 1998, the Company had no significant third-party debt.
The Company had working capital of $27.3 million at September 30, 1998 and
$5.7 million December 31, 1997.
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 through at least the next 18 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
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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 the Company's
costs in India are denominated in local currency and subject to exchange
fluctuations, which has not had any material adverse effect on the Company's
results of operations.
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.
RISKS ASSOCIATED WITH THE YEAR 2000
Historically, certain computer programs have been written using two digits
rather than four to define the applicable year, which could result in the
computer recognizing a date using "00" as the year 1900 rather than 2000. This
in turn, could result in major system failures or miscalculations, and is
generally referred to as the "Year 2000 Problem". The Company believes that it
has sufficiently assessed its state of readiness with respect to its Year 2000
compliance. The Company does not believe that Year 2000 compliance will result
in material investments by the Company, nor does the Company anticipate that the
Year 2000 Problem will have any adverse effects on the business operations or
financial performance of the Company. The Company does not believe that it has
any material exposure to the Year 2000 Problem with respect to its own
information systems. The Company believes that all of its systems correctly
define the Year 2000 and subsequent years. Previously, the Company reported that
its accounting system required an upgrade. In August 1998, the Company installed
a Year 2000 compliant upgrade to its financial system. There can be no
assurance, however, that the Year 2000 Problem will not adversely affect the
Company's business, operating results and financial condition.
The purchasing patterns of customers and potential customers may be
affected by issues associated with the Year 2000 Problem. As companies expend
significant resources to correct their current data storage solutions, these
expenditures may result in reduced funds to undertake projects such as those
offered by the Company. There can be no assurance that the Year 2000 Problem
will not adversely affect the Company's business, operating results and
financial condition. Conversely, the Year 2000 Problem may cause other companies
to accelerate purchases, thereby causing an increase in short-term demand and a
consequent decrease in long-term demand for the Company's services.
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RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities". SFAS No. 133 establishes accounting and
reporting standards for derivative instruments embedded in other contracts,
(collectively referred to as derivatives) and for hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. If certain conditions are met, a derivative may be specifically
designated as (a) a hedge of the exposure to changes in the fair value of a
recognized asset or liability or an unrecognized firm commitment, (b) a hedge of
the exposure to variability in cash flows attributable to a particular risk, or
(c) a hedge of the foreign currency exposure of a net investment in a foreign
operation, an unrecognized firm commitment, an available for sale security and a
forecasted transaction. The Company will be required to implement SFAS No. 133
for all fiscal quarters of fiscal years beginning after June 15, 1999. The
Company expects the adoption of this pronouncement will not have a material
effect on the Company's financial statements.
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PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
27. Financial Data Schedule for the period ended September 30, 1998.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the quarter for which this
report on Form 10-Q is filed.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, 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 12, 1998 By: /s/ Wijeyaraj Mahadeva
------------------------
Wijeyaraj Mahadeva,
Chairman of the Board and Chief Executive
Officer (Principal Executive Officer)
DATE: November 12, 1998 By: /s/ Gordon Coburn
-------------------
Gordon Coburn,
Chief Financial Officer and Treasurer
(Principal Financial and Accounting
Officer)
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