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 June 30, 1999 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 --------------------------------- (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 July 31, 1999: Class Number of Shares ----- ---------------- Class A Common Stock, par value 3,514,611 $.01 per share Class B Common Stock, par value $.01 per share 5,645,450
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION TABLE OF CONTENTS ----------------- Page ---- PART I. FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements................ 1 Condensed Consolidated Statements of Income (Unaudited) for the Three Months and Six Months Ended June 30, 1999 and 1998................................................... 2 Condensed Consolidated Statements of Financial Position (Unaudited) as of June 30, 1999 and December 31, 1998 ..... 3 Condensed Consolidated Statements of Cash Flows (Unaudited) for the Six Months Ended June 30, 1999 and 1998................................................... 4 Notes to Condensed Consolidated Financial Statements (Unaudited)................................................ 5 Item 2. Management's Discussion and Analysis of Results of Operations and Financial Condition.............. 9 PART II. OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders........ 17 Item 5. Other Information.......................................... 17 Item 6. Exhibits and Reports on Form 8-K........................... 18 SIGNATURES.......................................................... 19 (i)
PART I. FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements (unaudited) - 1 -
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF INCOME (unaudited) (in thousands, except per share data) <TABLE> <CAPTION> Three Months Ended June 30, Six Months Ended June 30, --------------------------- ------------------------- 1999 1998 1999 1998 ---- ---- ---- ---- <S> <C> <C> <C> <C> Revenues......................................... $ 17,900 $ 8,493 $ 35,035 $ 15,022 Revenues - related party......................... 3,598 4,175 6,889 7,884 -------- -------- -------- -------- Total revenues................................ 21,498 12,668 41,924 22,906 Cost of revenues................................. 11,149 7,326 21,860 13,255 -------- -------- -------- -------- Gross profit..................................... 10,349 5,342 20,064 9,651 Selling, general and administrative expenses...................................... 5,776 3,225 10,790 5,930 Depreciation and amortization expense............ 710 535 1,341 1,015 -------- -------- -------- -------- Income from operations........................... 3,863 1,582 7,933 2,706 Other income: Interest income............................... 247 48 522 79 Other income/(expense) - net.................. (29) 74 33 57 -------- -------- -------- -------- Total other income....................... 218 122 555 136 -------- -------- -------- -------- Income before provision for income taxes......... 4,081 1,704 8,488 2,842 Provision for income taxes....................... (1,526) (638) (3,174) (1,064) -------- -------- -------- -------- Net income....................................... $ 2,555 $ 1,066 $ 5,314 $ 1,778 ======== ======== ======== ======== Basic earnings per share......................... $ 0.28 $ 0.15 $ 0.58 $ 0.26 ======== ======== ======== ======== Diluted earnings per share....................... $ 0.27 $ 0.15 $ 0.55 $ 0.25 ======== ======== ======== ======== Weighted average number of common shares outstanding - Basic.................... 9,157 6,943 9,154 6,779 ======== ======== ======== ======== Dilutive Effect of Shares Issuable as of Period-End Under Stock Option Plans.............. 405 230 439 224 ======== ======== ======== ======== Adjustment of Shares Applicable to Exercised Stock Options During the Period.................. 3 -- 10 -- ======== ======== ======== ======== Weighted average number of common shares outstanding - Diluted.................. 9,565 7,173 9,603 7,003 ======== ======== ======== ======== Comprehensive Income: Net Income....................................... $ 2,555 $ 1,066 $ 5,314 $ 1,778 Foreign Currency Translation Adjustments......... (8) -- (13) 2 -------- -------- -------- -------- Other Comprehensive Income/(Loss), net of Tax:... $ (8) $ -- $ (13) $ 2 ======== ======== ======== ======== Comprehensive Income............................. $ 2,547 $ 1,066 $ 5,301 $ 1,780 ======== ======== ======== ======== </TABLE> The accompanying notes are an integral part of the condensed consolidated financial statements. - 2 -
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL POSITION (Unaudited) (in thousands, except par values) <TABLE> <CAPTION> JUNE 30, DECEMBER 31, 1999 1998 ------- ----------- ASSETS <S> <C> <C> Current assets: Cash and cash equivalents......................................... $ 29,359 $ 28,418 Trade accounts receivable, net of allowance of $274 for each period presented...................................... 10,811 9,230 Trade accounts receivable-related party........................... 1,854 1,877 Unbilled accounts receivable...................................... 892 1,088 Other current assets.............................................. 2,148 1,754 ---------- ---------- Total current assets.......................................... 45,064 42,367 ---------- ---------- Property and equipment, net of accumulated depreciation of $5,288 and $4,121, respectively............................................ 8,334 6,270 Goodwill, net......................................................... 1,671 1,830 Other assets.......................................................... 1,304 1,212 ---------- ---------- Total assets.................................................. $ 56,373 $ 51,679 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable.................................................. $ 1,077 $ 1,744 Accrued and other current liabilities............................. 9,252 11,207 ---------- ---------- Total current liabilities..................................... 10,329 12,951 Deferred income taxes................................................. 7,903 6,103 Due to related party.................................................. 2 9 ---------- ---------- Total liabilities............................................. 18,234 19,063 ---------- ---------- Commitments and Contingencies Stockholders' equity: Preferred stock, $.10 par value, 15,000 shares authorized, none issued....................................................... -- -- Class A common stock, $.01 par value, 100,000 shares authorized, 3,514 shares and 3,505 shares issued and outstanding at June 30, 1999 and December 31, 1998, respectively................. 35 35 Class B common stock, $.01 par value, 15,000 shares authorized, 5,645 shares issued and outstanding at June 30, 1999 and December 31, 1998, respectively................................. 57 57 Additional paid-in-capital............................................ 24,788 24,566 Retained earnings..................................................... 13,283 7,969 Cumulative translation adjustment..................................... (24) (11) ---------- ---------- Total stockholders' equity.................................... 38,139 32,616 ---------- ---------- Total liabilities and stockholders' equity.................... $ 56,373 $ 51,679 ========== ========== </TABLE> The accompanying notes are an integral part of the condensed consolidated financial statements. - 3 -
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) (in thousands) <TABLE> <CAPTION> FOR THE SIX MONTHS ENDED JUNE 30, --------------------------------- 1999 1998 ---------- ---------- <S> <C> <C> Cash flows from operating activities: Net income......................................................... $ 5,314 $ 1,778 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization.............................. 1,341 1,015 Provision for doubtful accounts............................ -- (62) Deferred income taxes...................................... 1,800 1,252 Changes in assets and liabilities: Accounts receivable........................................ (1,558) (1,478) Other current assets....................................... (198) (1,297) Other assets............................................... (92) 631 Accounts payable........................................... (667) (624) Accrued and other liabilities.............................. (1,955) 3,506 -------- -------- Net cash provided by operating activities.......................... 3,985 4,721 -------- -------- Cash flows from investing activities: Purchase of property and equipment................................. (3,247) (1,830) -------- -------- Net cash used in investing activities.............................. (3,247) (1,830) -------- -------- Cash flows from financing activities: Proceeds from issued shares/contributed capital, net............... 223 22,532 Payments to related party.......................................... (7) (6,623) -------- -------- Net cash provided by financing activities.......................... 216 15,909 -------- -------- Effect of Currency Translation..................................... (13) -- -------- -------- Increase in cash and cash equivalents ............................. 941 18,800 Cash and cash equivalents, beginning of year....................... 28,418 2,715 -------- -------- Cash and cash equivalents, end of period................... $ 29,359 $ 21,515 ======== ======== Supplemental disclosures of cash flow information: Cash paid during the period for income taxes................... $ 1,314 $ -- </TABLE> The accompanying notes are an integral part of the condensed consolidated financial statements. - 4 -
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (Dollar Amounts in Thousands) NOTE 1 - INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS: The accompanying unaudited condensed consolidated financial statements included herein have been prepared by Cognizant Technology Solutions Corporation (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 and should be read in conjunction with the Company's consolidated financial statements (and notes thereto) included in the Company's 1998 Annual Report on Form 10-K. 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 results that may be expected to occur for the entire year. Certain prior period amounts have been reclassified to conform with the 1999 presentation. NOTE 2 - COMPREHENSIVE INCOME: The Company's Comprehensive Income consists of net income and foreign currency translation adjustments (see unaudited Condensed Consolidated Statements of Comprehensive Income). Accumulated balances of Cumulative Translation Adjustments, as of June 30, 1999 and 1998 are as follows: Cumulative Translation Adjustment Balance December 31, 1998............................. $ (11) Period Change......................................... (13) ------- Balance June 30, 1999................................. $ (24) ======= Balance December 31, 1997............................. $ (2) Period Change......................................... 2 ------- Balance June 30, 1998................................. $ 0 ======= 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 Cognizant Corporation ("Cognizant"), the Company's then majority owner and controlling parent company. The net proceeds to the Company from the IPO were approximately $22.4 million after $845 of direct - 5 -
expenses. In July 1998, IMS Health Incorporated ("IMS Health") (the accounting successor to Cognizant) sold 437,550 shares of Class B Common Stock, which were converted to Class A Common Stock, pursuant to an over allotment option granted to the underwriters of the IPO. Of the total net proceeds received by the Company upon the consummation of its IPO, approximately $6.6 million was used to repay the related party balance then 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 voided. NOTE 4 - RELATED PARTY TRANSACTIONS: In July 1998, IMS Health sold 437,550 shares of Class B Common Stock pursuant to an over allotment option granted to the underwriters of the IPO. As of June 30, 1999, IMS Health owned approximately 61.6% of the outstanding Common Stock of the Company and held approximately 94.1% 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 for all periods prior to the IPO were allocated to the Company based on utilization of certain specific services. All subsequent services were performed under an intercompany services agreement with IMS Health. Total costs in connection with these services were approximately $175 and $850 for the six-month periods ended June 30, 1999 and 1998, respectively. NOTE 5 - ADOPTION OF STATEMENTS OF FINANCIAL ACCOUNTING STANDARDS: In March 1998, the American Institute of Certified Public Accountants (the "AICPA") issued Statement of Position ("SOP") 98-1, "Accounting For The Costs of Computer Software Developed Or Obtained For Internal Use." SOP 98-1 provides guidance on costs to be capitalized and when capitalization of such costs should commence. SOP 98-1 applies to costs incurred after adoption, including costs for software projects that are in progress at the time of the adoption. The Company has evaluated the impact of this SOP on its financial position and results of operations. The implementation of SOP 98-1 effective January 1, 1999 did not have a material effect on the Company's financial statements. In April 1998, the AICPA issued SOP 98-5, "Accounting For The Costs Of Start-up Activities." SOP 98-5 requires all costs of start-up activities to be expensed as incurred. SOP 98-5 is effective for financial statements for the years beginning after December 15, 1998. The Company has evaluated the impact of this SOP on its financial position and results of operations. The implementation of SOP 98-5 effective January 1, 1999 did not have a material effect on the Company's financial statements. - 6 -
In July 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of the FASB Statement No. 133, an Amendment of FASB Statement No. 133". SFAS No. 137 defers the effective date of FASB No. 133, which establishes accounting and reporting standards for derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. FASB No. 133 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. As a result of FASB No. 137, the Company will be required to implement SFAS No. 133 for all fiscal quarters of fiscal years beginning after June 15, 2000. The Company expects the adoption of this pronouncement will not have a material effect on the Company's financial statements. NOTE 6 - SEGMENT INFORMATION The Company delivers full life cycle solutions to complex software development and maintenance problems through the use of a seamless on-site and offshore consulting project team. These solutions 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 has adopted SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information." Information about the Company's operations and total assets in North America, Europe and Asia for the six month period ended June 30, 1999 and 1998 are as follows: <TABLE> <CAPTION> Three Months Ended Six Months Ended ------------------ ---------------- 1999 1998 1999 1998 ---- ---- ---- ---- <S> <C> <C> <C> <C> REVENUES (1) North America..................... $ 16,513 $ 10,468 $ 32,658 $ 19,012 Europe............................ 4,877 2,184 9,041 3,794 Asia.............................. 108 16 225 100 --------- --------- --------- ---------- Consolidated...................... $ 21,498 $ 12,668 $ 41,924 $ 22,906 ========= ========= ========= ========== OPERATING INCOME (1) North America..................... $ 2,967 $ 1,307 $ 6,184 $ 2,245 Europe............................ 876 273 1,706 450 Asia.............................. 20 2 43 11 --------- --------- --------- ---------- Consolidated...................... $ 3,863 $ 1,582 $ 7,933 $ 2,706 ========= ========= ========= ========== As of June 30, IDENTIFIABLE ASSETS 1999 1998 ---- ---- North America..................... $ 36,028 $ 31,050 Europe............................ 3,602 996 Asia.............................. 16,743 8,011 --------- --------- Consolidated...................... $ 56,373 $ 40,057 ========= ========= </TABLE> (1) Revenues and resulting operating income are attributed to regions based upon customer location. - 7 -
The Company, operating globally, provides software development and maintenance services for medium and large businesses. North American operations consist primarily of software development and maintenance consulting services in the United States and Canada. European operations consist primarily of software development and maintenance services principally in the United Kingdom and Germany. Asian operations consist primarily of software development and maintenance consulting services principally in India. In the second quarter of 1999, sales to one related party customer accounted for 16.7% of revenues and one third-party customer accounted for 19.7% of revenues. In the second quarter of 1998, sales to one related party customer accounted for 33.0% of revenues and one third-party customer accounted for 13.2% of revenues. NOTE 7 - CONTINGENCIES 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 business, financial condition and results of operations. 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 software development and maintenance services, there can be no assurance that the limitations of liability set forth in its contracts will be enforceable in all instances or will otherwise protect the Company from liability for damages. Although the Company has general liability insurance coverage, including coverage for errors or omissions, there can be no assurance that such coverage will continue to be available on reasonable terms or will be available in sufficient amounts to cover one or more large claims, or that the insurer will not disclaim coverage as to any future claim. The successful assertion of one or more large claims against the Company that exceed available insurance coverage or changes in the Company's insurance policies, including premium increases or the imposition of large deductible or co-insurance requirements, could have a material adverse effect on the Company's business, results of operations and financial condition. - 8 -
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 technology consulting 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 Incorporated ("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 incurred 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 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 - 9 -
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. - 10 -
RESULTS OF OPERATIONS The following table sets forth certain results of operations as a percentage of total revenue: <TABLE> <CAPTION> THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, --------------------------- ------------------------- 1999 1998 1999 1998 ---- ---- ---- ---- <S> <C> <C> <C> <C> Total revenues......................... 100.0% 100.0% 100.0% 100.0% Cost of revenues....................... 51.9 57.8 52.1 57.9 ------- ------- ------- ------- Gross profit........................ 48.1 42.2 47.9 42.1 Selling, general and administrative expense................................ 26.9 25.5 25.7 25.9 Depreciation and amortization expense.. 3.2 4.2 3.3 4.4 ------- ------- ------- ------- Income from operations.............. 18.0 12.5 18.9 11.8 Other income (expense): Interest income..................... 1.1 0.4 1.2 0.3 Other income (expense).............. (0.1) 0.6 0.1 0.3 ------- ------- ------- ------- Total other income (expense) 1.0 1.0 1.3 0.6 ------- ------- ------- ------- Income before provision for income taxes............................... 19.0 13.5 20.2 12.4 Provision for income taxes............. (7.1) (5.1) (7.5) (4.6) ------- ------- ------- ------- Net income ............................ 11.9% 8.4% 12.7% 7.8% ======= ======= ======= ======= </TABLE> Three Months Ended June 30, 1999 Compared to Three Months Ended June 30, 1998 Revenue. Revenue increased by 69.7%, or $8.8 million, from $12.7 million during the three months ended June 30, 1998 to $21.5 million during the three months ended June 30, 1999. This increase resulted primarily from a $11.0 million increase in software development, maintenance and Eurocurrency compliance services partially offset by an approximately $2.2 million decrease in Year 2000 Compliance Services. The percentage of revenues derived from unrelated parties increased from 67.0% during the three months ended June 30, 1998 to 83.3% during the three months ended June 30, 1999. 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. In the second quarter of 1999, sales to one related party customer accounted for 16.7% of revenues and one third-party customer accounted for 19.7% of revenues. In the second quarter of 1998, sales to one related party customer accounted for 33.0% of revenues and one third-party customer accounted for 13.2% 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 52.2%, or $3.8 million, from $7.3 million during the three months ended June 30, 1998 to $11.1 million during the three months ended June 30, 1999. The increase was due primarily to the increased cost resulting from the increase in the number of the Company's technical professionals from approximately 1,200 employees at June 30, 1998 to approximately 1,635 employees at June 30, 1999. The Company's gross profit increased by 93.7%, or approximately $5.0 million, from approximately $5.3 million during the three months ended June 30, 1998 to approximately $10.3 million during the three months ended June 30, 1999. Gross profit margin increased from 42.2% of revenues during the three months ended June 30, 1998 to 48.1% of revenues during the three months ended June 30, 1999. The increase in such gross profit margin was primarily attributable to the increased third- - 11 -
party revenue, which generally has higher margins, and a higher utilization level of technical professionals during the three months ended June 30, 1999 compared to the three months ended June 30, 1998. 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 72.5%, or $2.7 million, from $3.8 million during the three months ended June 30, 1998 to $6.5 million during the three months ended June 30, 1999, and increased as a percentage of revenue from 29.7% to 30.2%. The increase in such expenses 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. Income from Operations. Income from operations increased 144.2%, or $2.3 million, from $1.6 million during the three months ended June 30, 1998 to $3.9 million during the three months ended June 30, 1999, representing 12.5% and 18.0% 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 approximately $199,000 from approximately $48,000 during the three months ended June 30, 1998 to approximately $247,000 during the three months ended June 30, 1999. 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 operating cash balances. The Company recognized a net foreign currency exchange loss of approximately $29,000 during the three months ended June 30, 1999, as a result of the effect of changing exchange rates on the Company's transactions. Provision for Income Taxes. Up to the date of the IPO, the Company had been included in the consolidated federal income tax returns of The Dun & Bradstreet Corporation and Cognizant Corporation. 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 approximately $638,000 in the three months ended June 30, 1998 to $1.5 million in the three months ended June 30, 1999, with an effective tax rate of 37.4% in 1998 and 1999. Net Income. Net income increased from approximately $1.1 million for the three months ended June 30, 1998 to $2.6 million for the three months ended June 30, 1999, representing 8.4% and 11.9% as a percentage of revenues, respectively. SIX MONTHS ENDED JUNE 30, 1999 COMPARED TO SIX MONTHS ENDED JUNE 30, 1998 Revenue. Revenue increased by 83.0%, or $19.0 million, from $22.9 million during the six months ended June 30, 1998 to $41.9 million during the six months ended June 30, 1999. This increase resulted primarily from a $20.6 million increase in software development, - 12 -
maintenance and Eurocurrency compliance services partially offset by an approximately $1.6 million decrease in Year 2000 Compliance Services. The percentage of revenues derived from unrelated parties increased from 65.6% during the six months ended June 30, 1998 to 83.6% during the six months ended June 30, 1999. 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. During the six months ended June 30, 1999, sales to one related party customer accounted for 16.4% of revenues and one third-party customer accounted for 20.0% of revenues. During the six months ended June 30, 1998, sales to one related party customer accounted for 34.4% of revenues and two third-party customers accounted for 13.8% and 10.5% of revenues, respectively. Gross profit. The Company's cost of revenues increased by 64.9%, or $8.6 million, from $13.3 million during the six months ended June 30, 1998 to $21.9 million during the six months ended June 30, 1999. The increase was due primarily to the increased cost resulting from the increase in the number of the Company's technical professionals from approximately 1,200 employees at June 30, 1998 to approximately 1,635 employees at June 30, 1999. The Company's gross profit increased by 107.9%, or approximately $10.4 million, from approximately $9.7 million during the six months ended June 30, 1998 to approximately $20.1 million during the six months ended June 30, 1999. Gross profit margin increased from 42.1% of revenues during the six months ended June 30, 1998 to 47.9% of revenues during the six months ended June 30, 1999. The increase in such gross profit margin was primarily attributable to the increased third-party revenue and higher utilization levels of technical professionals discussed above. Selling, general and administrative expenses. Selling, general and administrative expenses, including depreciation and amortization, increased by 74.7%, or $5.2 million, from $6.9 million during the six months ended June 30, 1998 to $12.1 million during the six months ended June 30, 1999, but decreased as a percentage of revenue from 30.3% to 28.9%. The dollar increase in such expenses 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. Income from Operations. Income from operations increased 193.2%, or $5.2 million, from $2.7 million during the six months ended June 30, 1998 to $7.9 million during the six months ended June 30, 1999, representing 11.8% and 18.9% of revenues, respectively. The increase in operating margin was primarily due to the increased third-party revenue higher utilization levels of technical professionals discussed above. Other Income. Interest income increased by approximately $443,000 from approximately $79,000 during the six months ended June 30, 1998 to approximately $522,000 during the six months ended June 30, 1999. 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 operating cash balances. The Company recognized a net foreign currency exchange gain of approximately $33,000 during the six months ended June 30, 1999, as a result of changes in exchange rates on the Company's transactions. Provision for Income Taxes. The provision for income taxes increased from approximately $1.1 million in the six months ended June 30, 1998 to $3.2 million in the six months ended June 30, 1999, with an effective tax rate of 37.4% in 1998 and 1999. - 13 -
Net Income. Net income increased from approximately $1.8 million for the six months ended June 30, 1998 to $5.3 million for the six months ended June 30, 1999, representing 7.8% and 12.7% 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 its majority owner and controlling parent company IMS Health, accounting successor to Cognizant. 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, at that time, by Cognizant Corporation. 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 IPO 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 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 $4.0 million during the six months ended June 30, 1999 as compared to net cash provided by operating activities of $4.7 million during the six months ended June 30, 1998. The decrease results primarily from decreased level of accrued liabilities and increased other assets partially offset by increased net income and an increase in deferred taxes. Accounts receivable increased from $11.1 million at December 31, 1998 to $12.7 million at June 30, 1999. 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 $3.2 million for the six months ended June 30, 1999 as compared to net cash used of $1.8 million for the same period in 1998. The increase in 1999 compared to 1998 primarily reflects increased purchases of equipment to expand the Company's offshore development infrastructure. The Company's financing activities provided net cash of approximately $216,000 for the six months ended June 30, 1999 as compared to net cash provided by financing activities of approximately $15.9 million for the same period in 1998. Net cash provided by financing activities as of June 30, 1998 includes net proceeds from the IPO after the settlement of approximately $6.6 million of non-trade related-party balances to Cognizant Corporation. As of June 30, 1999, the Company had no significant third-party debt. The Company had working capital of $34.7 million at June 30, 1999 and $29.4 million at December 31, 1998. 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. - 14 -
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 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. As the assessment was completed using internal personnel, costs and time for such personnel were not specifically tracked. The Company, however, estimates that such costs were immaterial. There were no external costs incurred by the Company relating to its Year 2000 assessment. Costs incurred to date to address the Year 2000 problem have been immaterial and the Company does not believe that Year 2000 compliance will result in material investments by the Company in the future. The Company does not anticipate that the Year 2000 Problem will have any material 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 and believes that all of its business-critical systems correctly define the Year 2000 and subsequent years. There can be no assurance, however, that the Year 2000 Problem will not adversely affect the Company's business, operating results and financial condition. Contingency planning has been essentially completed in all of the Company's operations in order to address the most likely effects on the Company from external risks. These plans will address facilities and equipment, telecommunications infrastructure, and internal administrative - 15 -
processes. In addition, these plans will take into account human resource and communications issues that relate to the Company's employees. As more information emerges about services upon which the Company is critically reliant, these plans will be adjusted accordingly. 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. RECENT ACCOUNTING PRONOUNCEMENTS In March 1998, the American Institute of Certified Public Accountants (the "AICPA") issued Statement of Position ("SOP") 98-1, "Accounting For The Costs of Computer Software Developed Or Obtained For Internal Use." SOP 98-1 provides guidance on costs to be capitalized and when capitalization of such costs should commence. SOP 98-1 applies to costs incurred after adoption, including costs for software projects that are in progress at the time of the adoption. The Company has evaluated the impact of this SOP on its financial position and results of operations. The implementation of SOP 98-1 effective January 1, 1999 did not have a material effect on the Company's financial statements. In April 1998, the AICPA issued SOP 98-5, "Accounting For The Costs Of Start-up Activities." SOP 98-5 requires all costs of start-up activities to be expensed as incurred. SOP 98-5 is effective for financial statements for the years beginning after December 15, 1998. The Company has evaluated the impact of this SOP on its financial position and results of operations. The implementation of SOP 98-5 effective January 1, 1999 did not have a material effect on the Company's financial statements. In July 1999, the FASB issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of the FASB Statement No. 133, an Amendment of FASB Statement No. 133". SFAS No. 137 defers the effective date of FASB No. 133, which establishes accounting and reporting standards for derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. FASB No. 133 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. As a result of FASB No. 137, the Company will be required to implement SFAS No. 133 for all fiscal quarters of fiscal years beginning after June 15, 2000. The Company expects the adoption of this pronouncement will not have a material effect on the Company's financial statements. - 16 -
PART II. OTHER INFORMATION ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. The Annual Meeting of Stockholders of the Company was held on May 25, 1999. There were present at the meeting in person or by proxy stockholders holding an aggregate of 3,348,640 shares of Class A Common Stock and an aggregate of 56,454,500 shares of Class B Common Stock. The results of the vote taken at such meeting with respect to each nominee for director were as follows: Common Stock Nominees For Withheld --------------------- --- -------- Wijeyaraj Mahadeva 59,801,520 1,620 Anthony Bellomo 59,801,366 1,774 Victoria Fash 59,688,670 114,470 Robert W. Howe 59,801,566 1,574 John Klein 59,801,566 1,574 Venetia Kontogouris 59,801,570 1,570 A vote was taken on the proposal to adopt the 1999 Incentive Compensation Plan. Of the shares present at the meeting in person or by proxy, 57,865,712 shares were voted in favor of such proposal, 820,114 shares were voted against such proposal and 7,021 shares abstained from voting. A vote was taken on the proposal to adopt the Employee Stock Purchase Plan. Of the shares present at the meeting in person or by proxy, 58,671,418 shares were voted in favor of such proposal, 15,139 shares were voted against such proposal and 6,920 shares abstained from voting. Finally, a vote was taken on the proposal to ratify the appointment of PricewaterhouseCoopers LLP as the independent accountants of the Company for the fiscal year ending December 31, 1999. Of the shares present at the meeting in person or by proxy, 59,797,942 shares were voted in favor of such proposal, 1,073 shares were voted against such proposal and 4,125 shares of Common Stock abstained from voting. ITEM 5. Other Information. On April 13, 1999, Paul Cosgrave, a member of the Board of Directors of the Company (the "Board") since 1998, resigned from the Board. Concurrent with the effectiveness of such resignation, the Board elected Robert W. Howe to the Board in order to fill the vacancy created by Mr. Cosgrave's resignation. - 17 -
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits. 10.1 1999 Incentive Compensation Plan 10.2 Employee Stock Purchase Plan 27.1 Financial Data Schedule for the period ended June 30, 1999. (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. - 18 -
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: August 10, 1999 By: /s/ Wijeyaraj Mahadeva ---------------------------- Wijeyaraj Mahadeva, Chairman of the Board and Chief Executive Officer (Principal Executive Officer) DATE: August 10, 1999 By: /s/ Gordon Coburn ---------------------------- Gordon Coburn, Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer) - 19 -