ITEM 1. BUSINESS
OVERVIEW
Cognizant Technology Solutions Corporation ("CTS" or the "Company") delivers high-quality, cost-effective, full life cycle solutions to complex software development and maintenance problems that companies face as they transition to e-business. These information technology ("IT") services are delivered through the use of a seamless on-site and offshore consulting project team. The Company's solutions include application development and integration, application management, 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, along with Erisco Managed Care Technologies, Inc. ("Erisco"), IMS International, Inc., Nielsen Media Research, Inc., Pilot Software, Inc. and Strategic Technologies, Inc. and certain other entities, plus a majority interest in Gartner Group, Inc. were spun-off from The Dun & Bradstreet Corporation to form a new company, Cognizant Corporation. 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 initial public offering. On June 30, 1998, a majority interest in the Company, Erisco, IMS International and certain other entities were spun-off from Cognizant Corporation to form IMS Health. At December 31, 2001, IMS Health owned approximately 58.3% of the outstanding stock of the Company and held approximately 93.3% of the combined voting power of the Company's common stock.
On February 11, 2000, the Board of Directors declared a 2-for-1 stock split effected by a 100% dividend payable on March 16, 2000 to stockholders of record on March 2, 2000. The stock split has been reflected in the accompanying consolidated financial statements, and all applicable references as to the number of common shares and per share information have been restated. Appropriate adjustments have been made in the exercise price and number of shares subject to stock options. Stockholder equity accounts have been restated to reflect the reclassification of an amount equal to the par value of the increase in issued common shares from the additional paid-in-capital account to the common stock accounts.
On May 23, 2000, the stockholders of the Company approved an increase in the number of authorized Class B common Stock from 15,000,000 shares to 25,000,000 shares.
The Company provides professional IT services to its customers through an integrated business model that combines a technical and account management team located on-site at the customer location and eleven development centers located in India. The Company's core competencies include web-centric applications, data warehousing, component-based development, and legacy and client-server systems.
The Company markets and sells its technology consulting services directly through its professional staff, senior management and sales personnel. The Company operates out of its Teaneck, New Jersey headquarters and its regional and international offices. The number of customers for whom the Company has provided services has grown from 57 customers in 1999 to 90 customers in 2000 and 100 customers in 2001. The Company's customers include:
ACNielsen Corporation First Data Corporation ADP, Incorporated IMS Health Incorporated ("IMS Health") Brinker International, Incorporated Metropolitan Life Insurance Company CCC Information Services Incorporated Nielsen Media Research, Incorporated Computer Sciences Corporation PNC Bank The Dun & Bradstreet Corporation Royal & SunAlliance USA
INDUSTRY BACKGROUND
Many companies today face increasing customer demands to improve service levels, lower costs and shorten time to market. In this competitive environment, improving IT systems and leveraging the internet are critical to achieving these objectives. At the same time, the pace of technology evolution has accelerated. In order to remain competitive, companies are increasingly required to adopt emerging technologies, such as:
o e-business and e-commerce applications;
o data warehousing;
o supply chain management; and
o middleware / enterprise application integration.
These emerging technologies offer the promise of faster, more responsive, lower cost business operations. However, their development, integration and on-going management present major challenges and require a large number of highly skilled individuals trained in many diverse technologies. In addition, companies also require additional technical resources to maintain, enhance and re-engineer their core legacy systems for e-business and to address application management projects such as Eurocurrency compliance, decimalization in the securities industry, and the health insurance portability and accountability act ("HIPAA") regulations in the healthcare industry. Increasingly, companies turn to solutions providers such as CTS to provide these services.
Many companies have made the strategic decision to focus on their core competencies and reduce their cost structures rather than invest in the additional large IT staffs that are necessary to evaluate, implement and manage IT initiatives in a rapidly changing environment. Consequently, these companies have turned to IT service providers both to develop and implement new IT solutions and to maintain core systems.
As the global demand for IT services has increased, the number of qualified technical professionals has not kept pace with such demand. As a result, some IT service providers have
attempted to access the large talent pool in certain developing countries, particularly India. India is widely acknowledged as a leader in offshore software development and has the second largest pool of IT talent behind the U.S. Historically, IT service providers have used the offshore labor pool primarily to supplement the internal staffing needs of customers. However, evolving customer demands have led to the utilization of offshore resources for higher value-added services. Such services include application development, integration and maintenance. The use of offshore personnel can offer a number of benefits, including faster delivery of new IT solutions, more flexible scheduling and lower costs. However, utilizing an offshore workforce to provide value-added services presents a number of challenges to IT service providers.
The offshore implementation of value-added software services requires highly developed project management skills. Such skills are necessary to design, develop and deploy high-quality technology solutions in a timely and cost-effective manner. In addition, IT service providers must have the methodologies, processes and communications capabilities to successfully integrate offshore workforces with on-site personnel. Service providers must also have strong research and development capabilities and technology competency centers. Finally, service providers utilizing offshore workforces must continually recruit and manage their workforces to deliver solutions using emerging technologies. As a result of the increasing demand for global IT services, a significant opportunity exists for IT service providers that can successfully address the challenges in utilizing an offshore talent pool.
THE CTS SOLUTION
CTS is a leader in delivering high-quality, cost-effective, full life-cycle solutions to complex IT problems to clients transitioning to e-business through the use of a seamless on-site and offshore project team. These solutions are comprised of application development and integration, application management and re-engineering services.
The Company provides professional services to its customers through an integrated business model. The Company's business model combines a technical and account management team located on-site at the customer location and eleven development centers located in India. To support this business model, the Company has recruited and trained a current staff of approximately 2,650 programmers in India. The Company has also put in place well developed facilities, technology and communications infrastructure. By basing the Company's technical operations in India, the Company has access to a large pool of skilled, English-speaking IT and Internet technology professionals. Such IT and Internet technology professionals service customers on a cost basis significantly lower than in developed countries. The main elements of the CTS solution, which the Company believes differentiates it from other IT service providers, include the following:
ESTABLISHED AND SCALABLE PROPRIETARY PROCESSES. To facilitate the Company's cost-effective, on-time delivery of high-quality projects integrating an on-site and offshore team, the Company has developed proprietary methodologies. Such methodologies are encapsulated in the Company's QVIEW software engineering process, which is available to all on-site and offshore programmers. The Company utilizes this ISO 9000 certified process to define and implement projects from the design, development and deployment stages through to ongoing application maintenance. For most projects, QVIEW is used to make an extensive front-end assessment. This
assessment allows the Company to define the scope and risks of the project and subdivide the project into smaller phases with frequent deliverables and feedback from customers. The Company also utilizes its QVIEW process to detect, mitigate and correct possible quality defects and to establish appropriate contingencies for each project. In order to ensure implementation of the quality process, the Company assigns a quality facilitator to each project. This facilitator reports to a centralized quality assurance and software engineering group. This group performs, on a sample basis, continuous quality audits, deliverables verifications, metrics collection and analysis, which are used to continually improve processes and methodologies. The Company's processes and methodologies have proven to be scalable as the Company has significantly increased its number of offshore development centers, customers and projects. In addition, the Company is assessed by KPMG at Level 5 (on a 1 to 5 scale) of the Capability Maturity Model of the Software Engineering Institute at Carnegie Mellon University. The assessment for the Software Capability Maturity Model is widely regarded as the best means to measure the quality and maturity of an organization's software development and maintenance processes.
HIGHLY SKILLED WORKFORCE. The Company has placed significant emphasis on recruiting and training its workforce of highly skilled professionals. Such professionals must be versed in the Company's processes and methodologies, particularly the QVIEW software engineering process. The Company has over 240 project managers and senior technical personnel on its worldwide staff, many of whom have significant work experience in the United States and Europe. The Company's project managers and senior technical personnel provide in-depth project management expertise to customers. The Company maintains programs and personnel, including an extensive campus recruiting program in India, to hire and train the best available technical professionals in both legacy systems and emerging technologies. The Company provides five months of combined classroom and on-the-job training to new hires. The Company provides additional training each year to continually enhance the business practices, tools, technology and consulting skills of its professional staff.
RESEARCH & DEVELOPMENT AND COMPETENCY CENTERS. The Company has project experience and expertise across multiple architectures and technologies, and makes a substantial on-going investment in competency centers and research and development to keep abreast of the latest technology developments.
Most of the Company's programmers are trained in multiple technologies and architectures. As a result, the Company is able to react to customers' needs and quickly redeploy programmers to new technologies. To facilitate this ability, the Company has made a substantial investment in competency centers to leverage its knowledge base across the company. In addition, through its investment in research and development activities and the continuing education of technical personnel, the Company assures that its knowledge base and collective skill set keeps pace with emerging technologies. The ability to work in new technologies allows the Company to foster long-term relationships by addressing the needs of both its existing and new customers.
WELL DEVELOPED INFRASTRUCTURE. The Company's extensive facilities, technology and communications infrastructure facilitates the seamless integration of its on-site and offshore workforces. This is accomplished by permitting team members in different locations to access
common project information and to work directly on customer projects. This infrastructure allows for:
o rapid completion of projects;
o highest level of quality;
o off-peak utilization of customers' technological resources; and
o real-time access to project information by the on-site account manager or the customer.
By using the excess capacity of a customer's existing computing facilities during off-peak hours, the Company's offshore development centers can undertake additional projects without substantial customer investment in new hardware and software. In addition, for large projects with short time frames, the Company's offshore facilities allow for parallel processing of various development phases to accelerate delivery time.
STRATEGY
The Company's objective is to be a leading provider of full life-cycle e-business and application development projects, take full responsibility for on-going management of a client's software systems, and help our clients move legacy transformation projects through to completion. The Company provides services to its North American and European customers, supported by its offshore Indian development centers. The Company pursues the following strategies to achieve this objective:
DEVELOP LONG-TERM CUSTOMER RELATIONSHIPS AND STRATEGIC ALLIANCES. The Company seeks to develop long-term strategic relationships with its customers and business partners. The Company tries to leverage these relationships into additional project opportunities. For example, the knowledge of customers' systems gained during the performance of application management services provides the Company with a competitive advantage in securing additional software development and maintenance projects from these customers. In addition, the Company believes that through its working relationships with independent software vendors it can obtain projects from such vendors' customers due to the detailed knowledge gained in the development process. Finally, the Company has partnered with select IT service firms which offer complementary services in order to best meet customer requirements.
EXTEND SERVICE OFFERINGS AND SOLUTIONS. The Company has several teams dedicated to developing new service offerings in emerging technologies. These teams collaborate with the Company's customers to develop such offerings. For example, the Company is currently developing new solutions for portfolio analysis, program management, technology architecture and strategy, e-testing, legacy restoration, and digital security and forensics. To facilitate the development of new solutions, the Company invests in internal research and development and promotes knowledge building and sharing across the organization. In addition, the Company continues to enhance its capabilities and service offerings in the areas of Customer Relationship Management ("CRM") and Enterprise Resource Planning ("ERP"). The Company believes that
the continued expansion of its service offerings will reduce its reliance on any one technology initiative and foster long-term relationships with its customers. Because of the Company's low offshore cost structure, it is able to substantially leverage the cost of its investment in these activities.
ENHANCE PROCESSES, METHODOLOGIES AND PRODUCTIVITY TOOLSETS. The Company is committed to improving and enhancing its proprietary QView software engineering process and other methodologies and toolsets. With the rapid evolution of technology, the Company believes that continued investment in research and development is critical to its success. The Company is constantly designing and developing additional productivity software tools to automate testing processes and improve project estimation and risk assessment techniques. The Company continually refines its processes by utilizing groupware technology to share project experience and best practice methodologies across the organization.
EXPAND DOMESTIC AND INTERNATIONAL GEOGRAPHIC PRESENCE. As the Company expands its customer base, it plans to open additional sales and marketing offices in the United States and internationally. This will enable the Company to sell to and support existing and prospective customers. The Company has established sales and marketing offices in Atlanta, Chicago, Cincinnati, Dallas, Minneapolis, Los Angeles, San Francisco and Teaneck, NJ. In addition, the Company has been pursuing market opportunities in Europe through its U.K. office, which was established in the beginning of 1998. The Company operates in Canada through its Toronto office, which was established in 1997.
PURSUE SELECTIVE STRATEGIC ACQUISITIONS. The Company believes that opportunities exist in the fragmented IT services market to expand its business through selective strategic acquisitions and/or joint ventures. The Company believes that acquisition and/or joint venture candidates may enable it to expand its geographic presence, enter new technology areas or expand capacity, with a particular focus on European expansion.
SERVICES
The Company provides a broad range of software services, including:
o application development and integration;
o application management; and
o re-engineering.
The Company's range of services enables it to meet customer needs for systems development/integration, application management and re-engineering services. The Company uses its QVIEW software engineering process, its on-site and offshore delivery model and well developed facilities, technology and communications infrastructure to deliver these services. For each of these services, the Company utilizes its QVIEW proprietary processes and methodologies to define the execution and delivery of the projects.
APPLICATION DEVELOPMENT AND INTEGRATION SERVICES. The Company follows either of two alternative approaches to application development and integration:
o full life cycle application development, in which the Company assumes start-to-finish responsibility for analysis, design, implementation, testing and integration of systems generally performed under fixed bid contracts; or
o cooperative development, in which the Company's employees work with a customer's in-house IT personnel to jointly analyze, design, implement, test and integrate new systems.
In both cases, the Company's on-site team members work closely with the end-users of the application to develop specifications and define requirements. Detailed design, implementation and testing are generally performed offshore at the Company's eleven software development centers located in India. In addition, the Company maintains an on-site presence at the customer's location in order to address evolving customer needs and resulting changes to the project.
A key part of the Company's application development and integration offering is a suite of services to help organizations build and integrate e-business applications with the rest of the enterprise. In this suite of offerings, the Company leverages its skills in e-business applications development and enterprise application integration to build sophisticated e-business applications and to integrate these new applications and websites with mainstream and legacy systems. The Company builds and deploys robust, scalable and extensible Internet architectures for transaction intensive, mission critical applications. The Company has competency centers specializing in Microsoft, IBM and Sun Technologies. The Company builds secure applications using Secure Socket Layers ("SSL") standards and several advanced technologies including those from RSA Security Inc.
APPLICATION MANAGEMENT SERVICES. The Company provides services to help ensure that a customer's core operational systems are free of defects and responsive to end-users' changing needs. In doing so, the Company is often able to introduce product and process enhancements and improve service levels to customers requesting modifications and on-going support.
Through the Company's on-site and offshore delivery model, the Company is able to provide a range of support services to its customers. On-site team members often provide help desk services at the customer's facility. These team members typically carry pagers in the event of an emergency service request and are often available to quickly resolve customer problems from remote locations. More complex maintenance services, including modifications, enhancements and documentation, which typically have longer turn around times, are completed offshore. Such services are completed utilizing satellite and fiber-optic telecommunications and the resources of the Company's software development centers.
As part of its application management services, the Company assists customers in renovating their core systems to meet the requirements imposed by new regulations, new standards, or other external events. Such services include, or have previously included, Year 2000 compliance, Eurocurrency compliance, decimalization within the securities industry and HIPAA, a set of regulations for the healthcare industry.
RE-ENGINEERING SERVICES. Through the Company's re-engineering service offerings, the Company works with customers to migrate systems based on legacy computing environments to newer, open systems-based platforms and client/server architectures, often in response to the more stringent demands of e-business. The Company's re-engineering tools automate many of the processes required to implement advanced client/server technologies. Such automation substantially reduces the time and cost to perform these services. These tools enable the Company to perform source code analysis and to re-design target databases and convert certain programming languages. If necessary, the Company's software engineers also help customers re-design and convert user interfaces.
CUSTOMERS
The Company provides services through time and material ("T&M") and fixed bid contracts. The volume of work performed for specific customers is likely to vary from year to year, and a significant customer in one year may not use the Company's services in a subsequent year. In 1999, IMS Health and First Data Corporation each accounted for more than 10.0% of revenue. In 2000 and 2001, IMS Health accounted for more than 10.0% of revenue. Presented below is additional information about the Company's customers.
SALES AND MARKETING
The Company markets and sells its services directly through its professional staff, senior management and direct sales persons operating out of its Teaneck, New Jersey headquarters and business development offices in Atlanta, Chicago, Dallas, Minneapolis, Los Angeles San Francisco, Toronto, and London. The Company manages its business and results of operations on a geographic basis. At December 31, 2001, the Company had 41 direct sales persons and 64 account managers. The sales and marketing group works with the Company's technical team as the sales process moves closer to the customer's selection of an IT service provider. The duration of the sales process varies depending on the type of service, ranging from approximately two months to over one year. The account manager or sales executive works with the technical team to:
o define the scope, deliverables, assumptions and execution strategies for a proposed project;
o develop project estimates;
o prepare pricing and margin analyses; and
o finalize sales proposals.
Management reviews and approves proposals, which are then presented to the prospective customer. Sales and account management personnel remain actively involved in the project through the execution phase.
The Company focuses its marketing efforts on businesses with intensive information processing needs. The Company maintains a prospect/customer database, which is continuously updated and utilized throughout the sales cycle from prospect qualification to close. As a result of this marketing system, the Company prequalifies sales opportunities, and direct sales representatives are able to minimize the time spent on prospect qualification. In addition, substantial emphasis is placed on customer retention and expansion of services provided to existing customers.
COMPETITION
The IT services market includes a large number of participants, is subject to rapid change and is intensely competitive. This market includes participants from a variety of market segments, including:
o systems integration firms;
o contract programming companies;
o application software companies;
o Internet solutions providers;
o the professional services groups of computer equipment companies;
o facilities management and outsourcing companies; and
o "Big Five" accounting firms.
The market also includes numerous smaller local competitors in the various geographic markets in which the Company operates. The Company competes with, among others:
Accenture Ltd. Infosys, Inc. Alydaar Corp. Keane, Inc. Cap Gemini America, Inc. KPMG Consulting, Inc. Covansys Inc. Sapient Corporation Computer Horizons Corp. Satyam Computer Services Limited Computer Task Group, Inc. Syntel, Inc. CGI Group, Inc. Tanning Technology Corporation
Electronic Data Systems Corp Tata Consultancy Services IBM Global Services WIPRO Ltd. I-Gate Capital Corporation
In certain markets in which the Company competes, there are no significant barriers to entry. Current and potential competitors may introduce new and more competitive services, make strategic acquisitions or establish cooperative relationships among themselves or with third parties. As a result, these competitors increase the ability of their services to address the needs of customers. Many of the Company's competitors have significantly greater financial, technical and marketing resources and greater name recognition than us. The principal competitive factors affecting the markets for the Company's services include:
o performance and reliability;
o quality of technical support, training and services;
o responsiveness to customer needs;
o reputation, experience and financial stability; and
o competitive pricing of services.
The Company competes by offering:
o a well developed recruiting, training and retention model;
o a successful service delivery model;
o an excellent referral base;
o continual investment in process improvement and knowledge capture;
o investment in research and development; and
o continued focus on responsiveness to customer needs, quality of services, competitive prices, project management capabilities and technical expertise.
In order to be successful in the future, the Company must continue to respond promptly and effectively to technological change and competitors' innovations. There can be no assurance that the Company will be able to compete successfully against current and future competitors. The Company's failure to successfully compete could have a material adverse effect upon its business, results of operations and financial condition.
INTELLECTUAL PROPERTY
The Company's consulting business includes the co-development, with the customer, of software applications and other technology deliverables. These include written specifications and documentation in connection with specific customer engagements. The Company's future
success depends in part on its ability to protect its intellectual property rights. The Company presently holds no patents or registered copyrights. The Company relies upon a combination of copyright and trade secret laws, non-disclosure and other contractual arrangements and various security measures to protect its intellectual property rights. India is a member of the Berne Convention, and has agreed to recognize protections on copyrights conferred under the laws of foreign countries, including the laws of the United States. The Company believes that laws, rules, regulations and treaties in effect in the United States and India are adequate to protect it from misappropriation or unauthorized use of the Company's copyrights. However, there can be no assurance that such laws will not change and, in particular, that the laws of India will not change in ways that may prevent or restrict the transfer of software components, libraries and toolsets from India to the United States. There can be no assurance that the steps taken by the Company to protect its intellectual property rights will be adequate to deter misappropriation of any of the Company's intellectual property, or that the Company will be able to detect unauthorized use and take appropriate steps to enforce the Company's rights.
Pursuant to the License Agreement between CTS and IMS Health, all rights to the "Cognizant" name and certain related trade and service marks were transferred to the Company in July, 1998.
EMPLOYEES
At December 31, 2001, the Company employed 855 persons on a full-time basis in its North American headquarters and satellite offices and on-site North American customer locations. The Company also employed 110 persons on a full-time basis in its European satellite offices and on-site European customer locations and 2,960 persons on a full-time basis in its offshore software development centers in India. None of the Company's employees is subject to a collective bargaining arrangement. The Company considers its relations with employees to be good.
The Company's future success depends to a significant extent on its ability to attract, train and retain highly skilled software development professionals. In particular, the Company needs to attract, train and retain project managers, software engineers and other senior technical personnel. The Company believes that in both the United States and India there is a shortage of, and significant competition for, software development professionals with the advanced technological skills necessary to perform the services offered by the Company. The Company has an active recruitment program in India. The Company has developed a recruiting system and database that facilitates the rapid identification of skilled candidates. During the course of the year, the Company conducts extensive recruiting efforts at premier colleges and technical schools in India. The Company evaluates candidates based on academic performance, the results of a written aptitude test measuring problem-solving skills and a technical interview. In addition, the Company has an active lateral recruiting program.
Senior project managers are hired from leading consulting firms in the United States and India. The Company's senior management and substantially all of the project managers have experience working in the United States and Europe. This enhances the Company's ability to attract and retain other professionals with experience in the United States.
The Company also has adopted a career and education management program to define the employees' objectives and career plans. Through an intensive orientation and training program, the Company introduces new employees to the QVIEW software engineering process and its services.
ITEM 2.
ITEM 2. PROPERTIES
The Company's executive and business development office is located in Teaneck, New Jersey. The Company believes that its current facilities are adequate to support its existing operations. The Company also believes that it will be able to obtain suitable additional facilities on commercially reasonable terms on an "as needed" basis.
The Company occupies the following properties:
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the outcome of such claims and legal actions, if decided adversely, is not expected to have a material adverse effect on the Company's business, financial condition and results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTER TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Prior to June 1998, there was no established market for the Company's Class A Common Stock. Since June 19, 1998, the Class A Common Stock has traded on the Nasdaq National Market ("NNM") under the symbol "CTSH".
All of the issued and outstanding shares of Class B Common Stock are held by IMS Health. Each outstanding share of Class B Common Stock is convertible at the holder's option into one share of Class A Common Stock at any time prior to a Tax-Free Spin-Off (as defined below). If a Tax-Free Spin-Off occurs, the stockholders of IMS Health will receive Class B Common Stock, which will continue to have ten votes per share (as compared to one vote per share for Class A Common Stock). Such shares of Class B Common Stock shall convert upon transfer to Class A Common Stock. Additionally, each share of Class B Common Stock automatically converts into one share of Class A Common Stock if at any time the number of outstanding shares of Class B Common Stock represents less than 35.0% of the economic ownership represented by the aggregate number of shares of Common Stock then outstanding.
Except as provided below, any shares of Class B Common Stock transferred to a person other than IMS Health shall automatically convert to shares of Class A Common Stock upon such disposition. Shares of Class B Common Stock transferred to stockholders of IMS Health in a transaction intended to be on a tax-free basis (a "Tax-Free Spin-Off") under the Code shall not convert to shares of Class A Common Stock upon the occurrence of such Tax-Free Spin-Off.
Following a Tax-Free Spin-Off, shares of Class B Common Stock shall convert upon transfer to Class A Common Stock; provided, however, that shares of Class B Common Stock shall automatically convert into shares of Class A Common Stock on the fifth anniversary of the Tax-Free Spin-Off, unless prior to such Tax-Free Spin-Off, IMS Health delivers to the Company written advice of counsel reasonably satisfactory to the Company to the effect that (i) such conversion could adversely affect the ability of IMS Health to obtain a favorable ruling from the Internal Revenue Service that the distribution would be a Tax-Free Spin-Off or (ii) the Internal Revenue Service has adopted a general non-ruling policy on tax-free spin-offs and that such conversion could adversely affect the status of the transaction as a Tax-Free Spin-Off. If such written advice is received, approval of such conversion shall be submitted to a vote of the holders of the Common Stock as soon as practicable after the fifth anniversary of the Tax-Free Spin-Off, unless IMS Health delivers to the Company written advice of counsel reasonably satisfactory to the Company prior to such anniversary that such vote could adversely affect the status of the distribution as a Tax-Free Spin-Off, including the ability to obtain a favorable ruling from the Internal Revenue Service. If such written advice is delivered, such vote shall not be held. Approval of such conversion will require the affirmative vote of the holders of a majority of the shares of both Class A Common Stock and Class B Common Stock present and voting, voting together as a single class, with each share entitled to one vote for such purpose. No assurance can be given that such conversion would be consummated. The foregoing requirements are intended to ensure that tax-free treatment of a Tax-Free Spin-Off is preserved should the Internal Revenue Service challenge such automatic conversion as violating the 80.0% vote requirement currently required by the Code for a Tax-Free Spin-Off.
On February 11, 2000, the Board of Directors declared a 2-for-1 stock split effected by a 100% dividend payable on March 16, 2000 to stockholders of record on March 2, 2000. The stock split has been reflected in the accompanying financial statements, and all applicable references as to the number of common shares and per share information have been restated.
The following table sets forth the high and low sales price for the Class A Common Stock for each of the quarters since the quarter ended March 31, 2000 as reported on NNM. Such quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions.
Quarter Ended High Low --------------------------------- ------------ ------------ March 31, 2000................... $72.13 $36.50 June 30, 2000.................... $65.00 $24.25 September 30, 2000............... $49.00 $30.94 December 31, 2000................ $45.00 $28.88 March 31, 2001................... $53.75 $27.81 June 30, 2001.................... $47.60 $27.85 September 30, 2001............... $46.05 $18.25 December 31, 2001................ $45.31 $17.70
As of March 1, 2002, the approximate number of holders of record of the Class A Common Stock was 36 and the approximate number of beneficial holders of the Class A Common Stock was 5,300.
As of March 1, 2002, all of the outstanding Class B Common Stock of the Company was owned by IMS Health.
The Company has never declared or paid cash dividends on its Class A or Class B Common Stock. The Company currently intends to retain any future earnings to finance the growth of the business and, therefore, does not currently anticipate paying any cash dividends in the foreseeable future.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table sets forth selected consolidated historical financial data of the Company as of the dates and for the periods indicated. The selected consolidated financial data set forth below for the Company as of December 31, 2000 and 2001 and for each of the three years in the period ended December 31, 2001 have been derived from the audited financial statements included elsewhere herein. The selected consolidated financial data set forth below for the Company as of December 31, 1997, 1998 and 1999 and for each of the years ended December 31, 1997 and 1998 are derived from the audited financial statements not included elsewhere herein. The selected consolidated financial information for 1999, 2000 and 2001 should be read in conjunction with the Consolidated Financial Statements and the Notes and "Item 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
OVERVIEW
The Company delivers high-quality, cost-effective, full life cycle solutions to complex software development and maintenance problems that companies face as they transition to e-business. These IT services are delivered through the use of a seamless on-site and offshore consulting project team. The Company's service offerings include:
o application development and integration;
o application management; and
o re-engineering.
During 1996, the Company made a strategic decision to attract customers that were not affiliated with Cognizant Corporation or any of the former affiliates of The Dun & Bradstreet Corporation. As a result of the implementation of this strategy, the Company has successfully transitioned from a company primarily serving affiliated customers to a company whose customer base now consists primarily of unaffiliated third parties. For example, revenues derived from customers not currently or previously affiliated with The Dun & Bradstreet Corporation, Cognizant Corporation, IMS Health, and any of their respective subsidiaries grew from $50.5 million, or 56.8% of revenues, in 1999 to $92.3 million, or 67.4% of revenues, in 2000 and to $129 million, or 72.3% of revenues in 2001. Approximately 43.2%, 32.6% and 27.7% of the Company's revenues in 1999, 2000 and 2001, respectively, were generated from current and former affiliates including approximately 16.7%, 10.4% and 10.6%, respectively, from IMS Health and its current subsidiaries.
The Company has derived and believes that it will continue to derive a significant portion of its revenues from a limited number of large third-party customers. During 1999, 2000 and 2001, the Company's five largest customers (other than IMS Health and its current subsidiaries) accounted for 44.9%, 34.5% and 28.5% of revenues, respectively. In 1999, IMS Health and First Data Corporation accounted for more than 10.0% of revenue. In 2000 and 2001, IMS Health accounted for more than 10.0% of revenues. The volume of work performed for IMS Health and its subsidiaries and other customers is likely to vary from year to year. Major customers, whether affiliated or unaffiliated, in one year may not provide the same level of revenues in any subsequent year.
The tragic events of September 11, 2001 have significantly impacted our travel industry customers, which represent approximately 5% of revenues. In addition, we expect short-term logistical delays in launching new initiatives for existing and new customers. There is no evidence that these events have changed our customers' strategy of doing business in India.
Prior to fiscal 2000, Year 2000 compliance services were an important element of the Company's service offerings. Approximately 15.6% and 0.4% of the Company's revenues were derived from Year 2000 compliance services in 1999 and 2000, respectively. The Company
believes that it has successfully utilized its Year 2000 compliance expertise to establish new client relationships and to deepen its relationships with existing customers. The knowledge of customers' systems gained while performing Year 2000 compliance services gave the Company a competitive advantage in securing additional application development and application management projects for such customers.
Application development and integration services represented approximately 32.3%, 46.1% and 42.9% of revenues in 1999, 2000 and 2001, respectively. Application management services accounted for 44.0%, 47.0% and 51.8% of revenues in 1999, 2000 and 2001, respectively.
The Company's services are performed on either a time-and-materials or fixed-price basis. Revenues related to time-and-materials contracts are recognized as the service is performed. Revenues related to fixed-price contracts are recognized using the percentage-of-completion method of accounting. Under such method, 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 contract cost. Estimates are subject to adjustment as a project progresses, to reflect changes in expected completion costs. 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. Additionally, 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.
The majority of the Company's revenues are earned within North America. Revenues outside of North America totaled $17.7 million, $22.1 million, and $25.4 million in 1999, 2000, and 2001, respectively, based upon where the customers are located. Revenues from customers located outside of North America have been generated primarily in the United Kingdom and Germany. As a percentage of revenues, revenues outside of North America represented 19.9%, 16.1% and 14.3% in 1999, 2000 and 2001, respectively. The primary denomination for invoices issued by the Company is U.S. dollars, with the exception of invoices issued in Canada, Germany and the United Kingdom. Invoices issued in Canada, Germany and the United Kingdom are issued in local currency. Gains and losses as a result of fluctuations in foreign currency exchange rates have not had a significant impact on historical results of operations.
CRITICAL ACCOUNTING POLICIES, ESTIMATES AND RISKS
Financial Reporting Release No. 60, which was recently released by the Securities and Exchange Commission, requires all companies to include a discussion of critical accounting policies or methods used in the preparation of financial statements. Note 2 to the Consolidated Financial Statements includes a summary of the significant accounting policies and methods used in the preparation of the Company's Consolidated Financial Statements. The following is a brief discussion of the more significant accounting policies and methods used by the Company.
In addition, Financial Reporting Release No. 61 was recently released by the SEC to require all companies to include a discussion to address, among other things, liquidity, off-balance sheet arrangements, contractual obligations and commercial commitments.
The Company's discussion and analysis of its financial condition and results of operations are based upon its consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of financial statements in accordance with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, including the recoverability of tangible and intangible assets, disclosure of contingent assets and liabilities as of the date of the financial statements, and the reported amounts of revenues and expenses during the reported period.
On an on-going basis, the Company evaluates its estimates. The most significant estimates relate to the allowance for doubtful accounts, reserve for warranties, reserves for employee benefits, income taxes, depreciation of fixed assets and long-lived assets, contingencies and litigation and the recognition of revenue and profits based on the percentage of completion method of accounting for fixed bid contracts. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could vary from the estimates and assumptions used in the preparation of the accompanying financial statements.
All of the Company's software development centers, including a substantial majority of its employees are located in India. As a result, the Company may be subject to certain risks associated with international operations, including risks associated with foreign currency exchange rate fluctuations and risks associated with the application and imposition of protective legislation and regulations relating to import and export or otherwise resulting from foreign policy or the variability of foreign economic conditions. To date, the Company has not engaged in any hedging transactions to mitigate its risks relating to exchange rate fluctuations. Additional risks associated with international operations include difficulties in enforcing intellectual property rights, the burdens of complying with a wide variety of foreign laws, potentially adverse tax consequences, tariffs, quotas and other barriers.
The Company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements:
REVENUE RECOGNITION. The Company's services are entered into on either a T&M or fixed-price basis. Revenues related to T&M contracts are recognized as the service is performed. Revenues related to fixed-price contracts are recognized as the service is performed using the percentage-of-completion method of accounting, under which the sales value of performance, including estimated earnings thereon, is recognized on the basis of the percentage that each contract's cost to date bears to the total estimated cost. Fixed price contracts are cancelable subject to a specified notice period. All services provided by the Company through the date of cancellation are due and payable under the contract terms. The Company issues invoices related
to fixed price contracts based upon achievement of milestones during a project or other contractual terms. Differences between the timing of billings, based upon contract milestones or other contractual terms, and the recognition of revenue, based upon the percentage-of-completion method of accounting, are recognized as either unbilled or deferred revenue. Estimates are subject to adjustment as a project progresses to reflect changes in expected completion costs. The cumulative impact of any revision in estimates is reflected in the financial reporting period in which the change in estimate becomes known and any anticipated losses on contracts are recognized immediately. A reserve for warranty provisions under such contracts, which generally exist for ninety days past contract completion, is estimated and accrued during the contract period.
FOREIGN CURRENCY TRANSLATION. The assets and liabilities of the Company's Canadian and European subsidiaries are translated into U.S. dollars from local currencies at current exchange rates and revenues and expenses are translated from local currencies at average monthly exchange rates. The resulting translation adjustments are recorded in a separate component of stockholders' equity. For the Company's Indian subsidiary ("CTS India"), the functional currency is the U.S. dollar, since its sales are made primarily in the United States, the sales price is predominantly in U.S. dollars and there is a high volume of intercompany transactions denominated in U.S. dollars between CTS India and its U.S. affiliates. Non-monetary assets and liabilities are translated at historical exchange rates, while monetary assets and liabilities are translated at current exchange rates. The resulting gain (loss) is included in other income.
ALLOWANCE FOR DOUBTFUL ACCOUNTS. The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. If the financial condition of the Company's customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.
INCOME TAXES. The Company records a valuation allowance to reduce its deferred tax assets to the amount that is more likely than not to be realized. While the Company has considered future taxable income and on-going prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event the Company were to determine that it would be able to realize its deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. Likewise, should the Company determine that it would not be able to realize all or part of its net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made. Additionally, the Company provides deferred taxes on the earnings of its Indian subsidiary based on the assumption that those earnings will be repatriated. Should the Company subsequently be unable to repatriate such earnings based on regulatory or other factors, or decide not to repatriate these or future earnings, an adjustment to the deferred tax liability account would be credited to income in the period of such determination.
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated certain financial data expressed as a percentage of total revenue:
YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000
REVENUE. Revenue increased by 29.7%, or $40.7 million, from $137.0 million during 2000 to $177.8 million in 2001. This increase resulted primarily from a $27.7 million (42.9%) increase in application management and a $13.5 million (18.8%) increase in application development and integration, partially offset by an approximately $0.5 million (100.0%) decrease in Year 2000 compliance services. The Company provides services through T&M and fixed bid contracts. Over the course of the last three years fixed bid contracts have increased as a percent of revenues from 15.0% in 1999 to 15.1% in 2000 to 23.9% in 2001.
Sales to related parties on a year-over-year basis were relatively stable at 10.6% in 2001 compared to 10.4% in 2000. For statement of operations purposes, revenues from related parties only include revenues recognized during the period in which the related party was affiliated with the Company. During 2001 and 2000, no third party accounted for greater than 10% of revenues.
GROSS PROFIT. The Company's cost of revenues consists primarily of the cost of salaries, payroll taxes, benefits, immigration and travel for technical personnel, and the cost of sales commissions related to revenues. The Company's cost of revenues increased by 29.0%, or $20.4 million, from $70.4 million during 2000 to $90.8 million in 2001. The increase was due primarily to the increased cost resulting from the increase in the number of the Company's technical professionals from approximately 2,800 employees at December 31, 2000 to approximately 3,470 employees at December 31, 2001. The increased number of technical professionals is a direct result of greater demand for the Company's services. The Company's
gross profit increased by 30.5%, or approximately $20.3 million, from approximately $66.6 million during 2000 to $86.9 during 2001. Gross profit margin increased from 48.6% of revenues during 2000 to 48.9% of revenues in 2001. The increase in such gross profit margin was primarily attributable to a continued shift toward higher margin fixed bid contracts and a lower incentive compensation accrual in 2001 as compared to 2000.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses consist primarily of salaries, employee benefits, travel, promotion, communications, management, finance, administrative and occupancy costs. Selling, general and administrative expenses, including depreciation and amortization, increased by 26.8%, or $10.8 million, from $40.5 million during 2000 to $51.3 million during 2001, and decreased as a percentage of revenue from approximately 29.5% to 28.9%, respectively. The increase in such expenses in absolute dollars was due primarily to expenses incurred to expand the Company's sales and marketing activities and increased infrastructure expenses to support the Company's growth. The decrease in such expenses as a percentage of revenue was primarily due to the increased revenues that have resulted from the Company's expanded sales and marketing activities in the current and prior years.
INCOME FROM OPERATIONS. Income from operations increased 36.3%, or approximately $9.5 million, from approximately $26.1 million during 2000 to $35.6 million during 2001, representing approximately 19.1% and 20.0% of revenues, respectively. The increase in operating margin was primarily due to a continued shift toward higher margin fixed bid contracts and a lower incentive compensation accrual in 2001 as compared to 2000.
OTHER INCOME/EXPENSE. Other income/expense consists primarily of interest income offset, by foreign currency exchange losses and, in 2001, an impairment loss on an investment. Interest income decreased by approximately 5.6%, from $2.6 million during 2000 to $2.5 million during 2001. The decrease in such interest income was attributable primarily to lower interest rates, offset, in part, by higher operating cash balances. The Company recognized a net foreign currency exchange loss of approximately $767,000 during 2001, as a result of the effect of changing exchange rates on the Company's transactions. The Company recognized an impairment loss on its investment in Questra Corporation ("Questra") of approximately $2.0 million during the fourth quarter of 2001 in recognition of an other than temporary decline in value. The impairment loss was based upon an implied valuation of Questra as a result of a recent new round of venture capital funding in which the Company's equity interest in Questra was substantially diluted and investors, other than the Company, received preferential liquidation rights. The impairment loss, net of tax benefit, was $1.2 million or $0.06 per diluted share. (See Note 5 to the Consolidated Financial Statements).
PROVISION FOR INCOME TAXES. Historically, through 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 the federal and state income taxes calculated on the Company's stand-alone basis. The provision for income taxes increased from $10.6 million in 2000 to $13.2 million in 2001, with an effective tax rate of 37.4% in both years. The provision for income taxes reflects the Company's intent to repatriate earnings from its Indian subsidiary.
NET INCOME. Net income increased from approximately $17.7 million in 2000 to $22.2 million in 2001, representing approximately 12.9% and 12.5% as a percentage of revenues, respectively. The lower percentage in 2001 reflects the one-time write-off of the Company's investment in Questra, discussed previously.
RESULTS BY BUSINESS SEGMENT
The Company, operating globally, provides software services for medium and large businesses. North American operations consist primarily of software services in the United States and Canada. European operations consist of software services principally in the United Kingdom. Asian operations consist of software services principally in India. The Company is managed on a geographic basis. Accordingly, regional sales managers, sales managers, account managers, project teams and facilities are segmented geographically and decisions by the Company's chief operating decision maker regarding the allocation of assets and assessment of performance are based on such geographic segmentation. Revenues and resulting operating income are attributed to regions based upon customer location.
North American Segment
REVENUE. Revenue increased by 32.6%, or approximately $37.5 million, from approximately $114.9 million during 2000 to approximately $152.4 million in 2001. The increase in revenue was attributable primarily to increased market awareness and acceptance of the on-site/offshore software delivery model, as well as sales and marketing activities directed at the U.S. market for the Company's services.
INCOME FROM OPERATIONS. Income from operations increased 39.3%, or approximately $8.6 million, from approximately $21.9 million during 2000 to approximately $30.5 million during 2001. The increase in operating income was attributable primarily to increased revenues and achieving leverage on prior sales and marketing investments.
European Segment
REVENUE. Revenue increased by 10.2%, or approximately $2.1 million, from approximately $21.0 million during 2000 to approximately $23.1 million in 2001. The increase in revenue was attributable to the Company's sales and marketing activities in the United Kingdom, partially offset by weak demand for the Company's services elsewhere in Europe.
INCOME FROM OPERATIONS. Income from operations increased 16.0%, or approximately $0.6 million, from approximately $4.0 million during 2000 to $4.6 million during 2001. The increase in operating income was attributable primarily to increased revenues and achieving leverage on prior sales and marketing investments.
Asian Segment
REVENUE. Revenue increased by 98.6%, or $1.1 million, from $1.1 million during 2000 to $2.2 million in 2001. The increase in revenue was attributable primarily to the Company's success in India providing software services to domestic Indian companies as well as to Indian divisions of the Company's multi-national clients.
INCOME FROM OPERATIONS. Income from operations increased 109.3%, or approximately $0.2 million, from approximately $0.2 million during 2000 to $0.5 million during 2001. The increase in operating income was attributable primarily to increased revenues.
YEAR ENDED DECEMBER 31, 2000 COMPARED TO YEAR ENDED DECEMBER 31, 1999
REVENUE. Revenue increased by 54.1%, or $48.1 million, from $88.9 million during 1999 to $137.0 million in 2000. This increase resulted primarily from a $61.5 million (82.0%) increase in application development and integration, application management, re-engineering and other services partially offset by an approximately $13.4 million (96.5%) decrease in Year 2000 compliance services. The percentage of revenues derived from unrelated parties increased from 83.3% during 1999 to 89.6% during 2000. This increase resulted from the Company's continued effort to pursue unaffiliated third-party customers and expanded service offerings to existing unaffiliated customers. 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 2000, sales to related party customers accounted for 10.4% of revenues and no third party accounted for greater than 10% of revenues. During 1999, sales to related party customers accounted for 16.7% of revenues and one third-party customer accounted for 17.4% of revenues.
GROSS PROFIT. The Company's cost of revenues increased by 52.6%, or $24.3 million, from $46.2 million during 1999 to $70.4 million during 2000. The increase was due primarily to the increased cost resulting from the increase in the number of the Company's technical professionals from approximately 2,000 employees at December 31, 1999 to approximately 2,800 employees at December 31, 2000. The increased number of technical professionals is a direct result of greater demand for the Company's services. The Company's gross profit increased by 55.8%, or approximately $23.9 million, from approximately $42.7 million during 1999 to approximately $66.6 million during 2000. Gross profit margin increased from 48.1% of revenues during 1999 to 48.6% of revenues during 2000. The increase in such gross profit margin was primarily attributable to the increased third-party revenue and the shift toward newer, higher margin customers.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses, including depreciation and amortization, increased by 55.1%, or $14.4 million, from $26.1 million during 1999 to $40.5 million during 2000, and increased as a percentage of revenue from approximately 29.4% to 29.5%, respectively. The increase in such expenses in absolute dollars and as a percentage of revenue 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 57.0%, or approximately $9.5 million, from approximately $16.6 million during 1999 to approximately $26.1 million during 2000, representing approximately 18.7% and 19.1% of revenues, respectively. The increase in operating margin was primarily attributable to the increased third-party revenue and the shift toward newer, higher margin customers.
OTHER INCOME. Interest income increased by approximately 109.7%, from $1.3 million during 1999 to approximately $2.6 million during 2000. The increase in such interest income was attributable primarily to generally higher operating cash balances. The Company recognized a net foreign currency exchange loss of approximately $538,000 during 2000, as a result of the effect of changing exchange rates on the Company's transactions.
PROVISION FOR INCOME TAXES. The Company's provision for income taxes in the consolidated statements of income reflects the federal and state income taxes calculated on the Company's stand alone basis. The provision for income taxes increased from $6.7 million in 1999 to $10.6 million in 2000, with an effective tax rate of 37.4% in both 1999 and 2000.
NET INCOME. Net income increased from approximately $11.2 million in 1999 to approximately $17.7 million in 2000, representing approximately 12.6% and 12.9% as a percentage of revenues, respectively.
RESULTS BY BUSINESS SEGMENT
North American Segment
REVENUE. Revenue increased by 61.5%, or approximately $43.8 million, from approximately $71.2 million during 1999 to approximately $114.9 million in 2000. The increase in revenue was attributable primarily to increased market awareness and acceptance of the on-site/offshore software delivery model, as well as sales and marketing activities directed at the U.S. market for the Company's services.
INCOME FROM OPERATIONS. Income from operations increased 64.4%, or approximately $8.6 million, from approximately $13.3 million during 1999 to approximately $21.9 million during 2000. The increase in operating income was attributable primarily to increased revenues and achieving leverage on prior sales and marketing investments.
European Segment
REVENUE. Revenue increased by 20.8%, or approximately $3.6 million, from approximately $17.4 million during 1999 to approximately $21.0 million in 2000. The increase in revenue was attributable the Company's sales and marketing activities in the United Kingdom.
INCOME FROM OPERATIONS. Income from operations increased 23.1%, or approximately $0.7 million, from approximately $3.2 million during 1999 to approximately $4.0 million during 2000. The increase in operating income was attributable primarily to increased revenues and achieving leverage on prior sales and marketing investments.
Asian Segment
REVENUE. Revenue increased by 199.2%, or $0.8 million, from approximately $0.4 million during 1999 to approximately $1.2 million in 2000. The increase in revenue was attributable primarily to the Company's success in India providing software services to domestic Indian companies.
INCOME FROM OPERATIONS. Income from operations increased 100.0%, or approximately $0.1 million, from approximately $0.1 million during 1999 to approximately $0.2 million during 2000. The increase in operating income was attributable primarily to increased revenues.
LIQUIDITY AND CAPITAL RESOURCES
Historically, through the date of the IPO, the Company's primary sources of funding had been cash flow from operations and intercompany cash transfers with its majority owner and controlling parent company Cognizant Corporation and IMS Health. In June 1998, the Company consummated its initial public offering of 5,834,000 shares of its Class A Common Stock at a price to the public of $5.00 per share, of which 5,000,000 shares were issued and sold by the Company and 834,000 shares were sold, at that time, by Cognizant Corporation. The 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 initial public offering were invested in short-term, investment grade, interest bearing securities, after the Company used a portion of the net proceeds to repay approximately $6.6 million of then-existing non-trade related party balances to Cognizant Corporation. The Company has used and plans to use the remainder of the net proceeds from the offering as well as other cash for (i) expansion of existing operations, including its offshore software development centers; (ii) continued development of new service lines and possible acquisitions of related businesses including cost and equity investments; and (iii) general corporate purposes including working capital.
Net cash provided by operating activities was approximately $32.1 million, $30.2 million and $19.4 million for the years ended December 31, 2001, 2000 and 1999, respectively. The increase in 2001 as compared to the prior year resulted primarily from increased tax benefits related to stock plans, increased depreciation and amortization, a smaller increase in accounts receivable and increased net income, offset, in part, by decreased levels of year-end accrued liabilities and accounts payable, due primarily to the timing of payments. The increase for 2000 compared to 1999 results primarily from increased levels of accrued liabilities and accounts payable, increased net income and an increase in deferred taxes, partially offset, in part, by increases in accounts receivable and other current assets. Trade accounts receivable increased from $10.0 million at December 31, 1999 to $20.5 million at December 31, 2000 and to $22.5 million at December 31, 2001. Unbilled accounts receivable increased from $1.1 million at December 31, 1999 to $1.9 million at December 31, 2000 and to $5.4 million at December 31, 2001. The increase in trade accounts receivable during 2001 was due primarily to increased revenue. The increase in unbilled accounts receivable in 2001 compared to prior years was primarily related to the increase in the percentage of revenues derived from fixed bid contracts and the related timing of contractual billings. 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. At December 31, 2001, the Company's day's sales outstanding, including unbilled receivables, was approximately 59 days, as compared to 50 days and 43 days at December 31, 2000 and 1999.
The Company's investing activities used net cash of $14.9 million, $12.6 million and $5.9 million for the years ended December 31, 2001, 2000 and 1999, respectively. The increase in 2001 compared to 2000 primarily reflects the Company's increased purchases of land, buildings and equipment to expand the Company's offshore development infrastructure. The increase in
2000 of net cash used in investing activities compared to 1999 primarily reflects an increase in purchases of property and equipment.
In June 2000, the Company announced a strategic relationship with Trident Capital, a leading venture capital firm, to jointly invest in emerging e-business service and technology companies. In accordance with this strategy, the Company invested approximately $2 million in Questra Corporation, an e-business software and consulting firm headquartered in Rochester, New York, in return for an initial 5.8% equity interest. Trident Capital also independently made a direct investment in Questra Corporation. Based upon an implied valuation of Questra as a result of a recent new round of venture capital funding in which the Company's equity interest in Questra was substantially diluted and investors, other than the Company, received preferential liquidation rights, the Company recorded an impairment loss for the full $2.0 million original investment in recognition of an other than temporary impairment. The Company's investment is being accounted for under the cost basis of accounting. (See Note 5 to the Consolidated Financial Statements.)
The Company's financing activities provided net cash of $6.0 million, $1.8 million and $0.7 million for the years ended December 31, 2001, 2000 and 1999, respectively. The increase in each year was primarily related to a higher level of cash proceeds from the exercise of stock options and employee purchases of stock.
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 for at least the next 12 months. The Company's ability to expand and grow its business in accordance with current plans, to make acquisitions and form joint ventures and to meet its long-term capital requirements beyond this 12-month period will depend on many factors, including the rate, if any, at which its cash flow increases, its ability and willingness to accomplish acquisitions and joint ventures with capital stock and the availability to the Company of public and private debt and equity financing. The Company cannot be certain that additional financing, if required, will be available on terms favorable to it, if at all.
At December 31, 2001 and 2000, the Company had cash and cash equivalents of approximately $85 million and $62 million, respectively. As of December 31, 2001 and 2000 the Company had no significant third party debt. The Company had working capital of approximately $95.6 and $61.5 million at December 31, 2001 and 2000, respectively. Accordingly, the Company does not anticipate any near-term liquidity issues.
As of December 31, 2001, the Company has entered into fixed capital commitments related to its India development center expansion program of approximately $10.7 million, of which $7.6 million has been spent to date. The multi-phase program will encompass the construction of three fully owned development centers containing approximately 600,000 square feet of space in Pune, Chennai and Calcutta. Total costs related to this program are expected to be approximately $35.6 million, which the Company expects to fund internally.
The Company leases office space and equipment under operating leases, which expire at various dates through the year 2010. Certain leases contain renewal provisions and generally require the Company to pay utilities, insurance, taxes, and other operating expenses.
Approximate future minimum rental payments under operating leases that have initial or remaining lease terms in excess of one year as of December 31, 2001 are as follows:
2002.....................................................$4.8 million 2003......................................................4.3 million 2004......................................................2.8 million 2005......................................................1.4 million 2006......................................................0.8 million Thereafter................................................2.0 million Total minimum lease payments............................$16.1 million
The Company does not engage in hedging activities nor has it entered into transactions, arrangements or other relationships with unconsolidated entities or other persons that are likely to affect liquidity or the availability of or requirements for capital resources.
RELATED PARTY TRANSACTIONS AND TRANSACTIONS WITH AFFILIATES
As indicated in Notes 1 and 10 to the consolidated financial statements, the Company has entered into various agreements with IMS Health, who owned a majority and controlling interest in the outstanding Common Stock of the Company (58.3%) and held approximately 93.3% of the combined voting power of the Company's Common Stock at December 31, 2001.
IMS Health currently provides the Company with certain administrative services, including payroll and payables processing and permits the Company to participate in IMS Health's business insurance plans. In prior periods, IMS Health provided certain other services such as tax planning and compliance, which have now been transitioned to the Company. Costs for all periods prior to the Company's IPO were allocated to the Company based on utilization of certain specific services. All subsequent services were performed and charged to the Company under the CTS/IMS Health intercompany services agreement that was negotiated between the parties on an arms length basis.
The Company and IMS Health have entered into Master Services Agreements pursuant to which the Company provides IT services to IMS Health. The IT services are provided to IMS Health on terms that are comparable to unrelated third parties. The same is true for IT services provided to former affiliates of D&B and Cognizant Corporation, former parents of the Company, and former and present affiliates of IMS Health. In 2001, the Company recognized related party revenues totaling $18.8 million for services performed for IMS Health. In 2000, the Company recognized related party revenues totaling $14.3 million including revenues from IMS Health and Strategic Technologies (through August 30, 2000). In 1999, the Company recognized related party revenues totaling $14.8 million including revenues from IMS Health and Strategic Technologies.
In December 2001, the Company paid IMS Health a one-time fee of approximately $825,000 under an alliance agreement in which the Company was named "vendor of choice" for IT services to the pharmaceutical industry. This agreement was negotiated between the parties on an arms-length basis.
In addition, the Company has a certain relationship with Erisco, which is now a wholly owned subsidiary of The Trizetto Group, Inc. ("Trizetto"). As of December 31, 2001, IMS Health owned approximately 26.8% of the outstanding common stock of Trizetto. During 2001 the Company recorded revenues from Erisco of approximately $401,000 and payments to Erisco for commissions and marketing fees of approximately $1.0 million.
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 the Company's 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 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.
RECENT ACCOUNTING PRONOUNCEMENTS
During 2000 and 2001, various new accounting pronouncements were issued which may impact the Company's financial statements. (See Note 2 to the Consolidated Financial Statements.)
FORWARD LOOKING STATEMENTS
The statements contained in this Annual Report on Form 10-K 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 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, in the United States, Europe 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; and (xi) general economic conditions. The Company's actual results may differ materially from the results disclosed in such forward-looking statements.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements required to be filed pursuant to this Item 8 are appended to this Annual Report on Form 10-K. A list of the financial statements filed and financial statement schedule herewith is found at "Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K."
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY
The information relating to the Company's directors, nominees for election as directors and executive officers under the headings "Election of Directors" and "Executive Officers" in the Company's definitive proxy statement for the 2002 Annual Meeting of Stockholders is incorporated herein by reference to such proxy statement.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The discussion under the heading "Executive Compensation" in the Company's definitive proxy statement for the 2002 Annual Meeting of Stockholders is incorporated herein by reference to such proxy statement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The discussion under the heading "Security Ownership of Certain Beneficial Owners and Management" in the Company's definitive proxy statement for the 2002 Annual Meeting of Stockholders is incorporated herein by reference to such proxy statement.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The discussion under the heading "Certain Relationships and Related Transactions" in the Company's definitive proxy statement for the 2002 Annual Meeting of Stockholders is incorporated herein by reference to such proxy statement.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K
(a) (1) Consolidated Financial Statements.
Reference is made to the Index to Consolidated Financial Statements on Page.
(a) (2) Consolidated Financial Statement Schedule.
Reference is made to the Index to Financial Statement Schedule on Page .
(a) (3) Exhibits.
Reference is made to the Index to Exhibits on Page 40.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the quarter ended December 31, 2001.
Schedules other than as listed above are omitted as not required or inapplicable or because the required information is provided in the consolidated financial statements, including the notes thereto.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 this 11th day of March, 2002.
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
By: /s/Wijeyaraj Mahadeva ----------------------------------- Wijeyaraj Mahadeva, Chairman of the Board and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
- -----------------
* A management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of Form 10-K.
** Filed herewith. All other exhibits previously filed.
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
Page ----
Consolidated Financial Statements:
Report of Independent Accountants...................................
Consolidated Statements of Financial Position as of December 31, 2001 and 2000........................................
Consolidated Statements of Operations for the years ended December 31, 2001, 2000 and 1999......................
Consolidated Statements of Stockholders' Equity for the years ended December 31, 2001, 2000 and 1999......................
Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2000 and 1999......................
Notes to Consolidated Financial Statements..........................
Unaudited Quarterly Financial Data.....................................
Financial Statement Schedule: Schedule of Valuation and Qualifying Accounts.................
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REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders of Cognizant Technology Solutions Corporation:
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, cash flows and stockholders' equity listed in the accompanying index present fairly, in all material respects, the financial position of Cognizant Technology Solutions Corporation and its subsidiaries at December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP New York, New York February 4, 2002
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COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION CONSOLIDATED STATEMENTS OF FINANCIAL POSITION (in thousands, except par values)
F - 3
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data)
F - 4
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (in thousands)
F - 5
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
F - 6
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share data)
1. BASIS OF PRESENTATION
Cognizant Technology Solutions Corporation (the "Company" or "CTS") is principally engaged in providing high-quality, cost-effective, full life cycle solutions to complex software development and maintenance requirements that companies face as they transition to e-business. The Company has operations and subsidiaries in India, the United Kingdom, Germany, Canada and the United States. These IT services are delivered through the use of a seamless on-site and offshore consulting project team. These solutions include application development and integration, application management, 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 ("D&B") and its operating units. These operating units principally included A.C.Nielsen, Dun & Bradstreet Information Services, Dun & Bradstreet Software, Erisco, Inc. ("Erisco"), IMS International, Inc. ("IMS International"), NCH Promotional Services, Inc., Nielsen Media Research, Inc. ("Nielsen Media Research"), The Reuben H. Donnelley Corporation, Pilot Software, Inc. ("Pilot Software") and Strategic Technologies, Inc. ("Strategic Technologies"), and a majority interest in Gartner Group, Inc. ("Gartner Group"). In November 1996, the Company, Erisco, IMS International, Nielsen Media Research, Pilot Software, Strategic Technologies and certain other entities, plus a majority interest in Gartner Group, were spun-off from D&B to form Cognizant, the then majority owner and controlling parent of the Company. At that time, ACNielsen was separately spun-off from D&B and Dun & Bradstreet Software was sold to GEAC Software. In 1997, Cognizant sold Pilot Software to a third party.
In 1997, the Company purchased the 24.0% minority interest in its Indian subsidiary from a third party for $3,468 making the Indian subsidiary wholly owned by the Company.
On January 15, 1998, Cognizant announced that it would, subject to certain conditions, reorganize itself (the "Reorganization"), by spinning the Nielsen Media Research business from the rest of its businesses, creating two publicly traded companies, IMS Health Corporation ("IMS Health") and Nielsen Media Research. The reorganization became effective on July 1, 1998. The shares of the Company previously held by Cognizant are now held by IMS Health and all services previously provided to the Company by Cognizant are now being provided by IMS Health.
In June 1998, the Company completed its IPO. (See Note 3 to the Consolidated Financial Statements.) As of December 31, 2001, IMS Health owned a majority and controlling interest in the outstanding Common Stock of the Company (58.3%) and held approximately 93.3% 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 and permits the Company to participate in IMS Health's business insurance plans. In prior periods, IMS Health provided certain other services such as tax planning and compliance, which have now been transitioned to the Company. Certain employees also participate in IMS Health's employee benefit plans. Costs for these services for all periods prior to the IPO were allocated to the Company based on utilization of
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COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share data)
certain specific services. All subsequent services were performed and charged to the Company under the CTS / IMS Health intercompany services agreement. (See also Note 10 to the Consolidated Financial Statements.)
On February 11, 2000, the Board of Directors declared a 2-for-1 stock split of Class A and Class B Common Stock effected by a 100% dividend payable on March 16, 2000 to stockholders of record on March 2, 2000. The stock split has been reflected in the accompanying financial statements, and all applicable references to the number of outstanding common shares and per share information has been restated. Appropriate adjustments have been made in the exercise price and number of shares subject to stock options. Stockholders' equity account have been restated to reflect the reclassification of an amount equal to the par value of the increase in issued common shares from the capital in excess of par value account to the common stock accounts.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION. The consolidated financial statements reflect the consolidated financial position, results of operations and cash flows of the Company and its consolidated subsidiaries as if it were a separate entity for all periods presented. All intercompany transactions are eliminated.
CASH AND CASH EQUIVALENTS. Cash and cash equivalents primarily include time and demand deposits in the Company's operating bank accounts. The Company considers all highly liquid instruments with an initial maturity of three months or less to be cash equivalents.
INVESTMENTS. Investments in business entities in which the Company does not have control or the ability to exercise significant influence over the operating and financial policies are accounted for under the cost method. Investments are evaluated, at each balance sheet date, for impairment.
PROPERTY AND EQUIPMENT. Property and equipment are stated at cost, net of accumulated depreciation. Depreciation is calculated on the straight-line basis over the estimated useful lives of the assets. Leasehold improvements are amortized on a straight-line basis over the shorter of the term of the lease or the estimated useful life of the improvement. Maintenance and repairs are expensed as incurred, while renewals and betterments are capitalized.
PURCHASED SOFTWARE. Purchased software that is intended for internal use is capitalized, including the salaries and benefits of employees that are directly involved in the installation of such software. The capitalized costs are amortized on a straight-line method over the lesser of three years or its useful life.
GOODWILL. Goodwill represents the excess of the purchase price of the former minority interest in the Company's Indian subsidiary over the fair values of amounts assigned to the incremental net assets acquired. Amortization expense has been recorded using the straight-line method over a period of seven years. Amortization expense was $317 for each of the years ended December 31, 2001, 2000 and 1999. Accumulated amortization was $1,345, $1,028 and $711 at December 31,
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COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share data)
2001, 2000 and 1999, respectively. In accordance with Statement of Financial Accounting Standards ("SFAS") No. 142 "Goodwill and Other Intangible Assets" ("FAS 142"), the Company will no longer amortize its remaining goodwill balance for years beginning after December 31, 2001.
IMPAIRMENT OF LONG-LIVED ASSETS. In accordance with Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," the Company reviews for impairment of long-lived assets and certain identifiable intangibles whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In general, the Company will recognize an impairment loss when the sum of undiscounted expected future cash flows is less than the carrying amount of such assets. The measurement for such an impairment loss is then based on the fair value of the asset.
REVENUE RECOGNITION. The Company's services are entered into on either a time-and-materials or fixed-price basis. Revenues related to time-and-material contracts are recognized as the service is performed. Revenues related to fixed-price contracts are recognized as the service is performed using the percentage-of-completion method of accounting, under which the sales value of performance, including estimated earnings thereon, is recognized on the basis of the percentage that each contract's cost to date bears to the total estimated cost. Fixed price contracts are cancellable subject to a specified notice period. All services provided by the Company through the date of cancellation are due and payable under the contract terms. The Company issues invoices related to fixed price contracts based upon achievement of milestones during a project or other contractual terms. Differences between the timing of billings, based upon contract milestones or other contractual terms, and the recognition of revenue, based upon the percentage-of-completion method of accounting, are recognized as either unbilled or deferred revenue. Estimates are subject to adjustment as a project progresses to reflect changes in expected completion costs. The cumulative impact of any revision in estimates is reflected in the financial reporting period in which the change in estimate becomes known and any anticipated losses on contracts are recognized immediately. A reserve for warranty provisions under such contracts, which generally exist for ninety days past contract completion, is estimated and accrued during the contract period.
UNBILLED ACCOUNTS RECEIVABLE. Unbilled accounts receivable represent revenues on contracts to be billed, in subsequent periods, as per the terms of the contracts.
FOREIGN CURRENCY TRANSLATION. The assets and liabilities of the Company's Canadian and European subsidiaries are translated into U.S. dollars from local currencies at current exchange rates and revenues and expenses are translated from local currencies at average monthly exchange rates. The resulting translation adjustments are recorded in a separate component of stockholders' equity. For the Company's Indian subsidiary ("CTS India"), the functional currency is the U.S. dollar, since its sales are made primarily in the United States, the sales price is predominantly in U.S. dollars and there is a high volume of intercompany transactions denominated in U.S. dollars between CTS India and its U.S. affiliates. Non-monetary assets and liabilities are translated at historical exchange rates, while monetary assets and liabilities are translated at current exchange rates. The resulting gain (loss) is included in other income.
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COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share data)
RISKS AND UNCERTAINTIES. The preparation of financial statements in accordance with generally accepted accounting principles in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, including the recoverability of tangible and intangible assets, disclosure of contingent assets and liabilities as of the date of the financial statements, and the reported amounts of revenues and expenses during the reported period. The most significant estimates relate to the allowance for doubtful accounts, reserve for warranties, reserves for employee benefits, depreciation of fixed assets and long-lived assets, contingencies and litigation and the recognition of revenue and profits based on the percentage of completion method of accounting for fixed bid contracts. Actual results could vary from the estimates and assumptions used in the preparation of the accompanying financial statements.
All of the Company's software development centers, including a substantial majority of its employees are located in India. As a result, the Company may be subject to certain risks associated with international operations, including risks associated with foreign currency exchange rate fluctuations and risks associated with the application and imposition of protective legislation and regulations relating to import and export or otherwise resulting from foreign policy or the variability of foreign economic conditions. To date, the Company has not engaged in any significant hedging transactions to mitigate its risks relating to exchange rate fluctuations. Additional risks associated with international operations include difficulties in enforcing intellectual property rights, the burdens of complying with a wide variety of foreign laws, potentially adverse tax consequences, tariffs, quotas and other barriers.
CONCENTRATION OF CREDIT RISK. Financial instruments that potentially subject the Company to significant concentrations of credit risk consist primarily of cash and cash equivalents and trade accounts receivable. The Company maintains its cash investments with high credit quality financial institutions in investment-grade, short term debt securities and limits the amount of credit exposure to any one commercial issuer.
INCOME TAXES. Prior to the consummation of the Company's IPO, the Company had been included in the federal and certain state income tax returns of Cognizant and D&B. The provision for income taxes in the Company's consolidated financial statements has been calculated on a separate company basis. Income tax benefits realized by the Company and utilized by Cognizant or D&B are included in stockholders' equity. The Company is no longer included in the consolidated return of its majority owner and controlling parent company, and is required to file separate income tax returns.
On a stand-alone basis, the Company provides for income taxes utilizing the asset and liability method of accounting for income taxes. Under this method, deferred income taxes are recorded to reflect the tax consequences in future years of differences between the tax basis of assets and liabilities and their financial reporting amounts at each balance sheet date, based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. If it is determined that it is more likely than not that future tax benefits associated with a deferred tax asset will not be realized, a valuation allowance is provided. The effect on deferred tax assets and liabilities of a change in the tax rates is recognized in income in the period that includes the enactment date.
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COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share data)
CTS India is an export oriented company that is entitled to claim a tax holiday for a period of nine years from April 1995 through March 2004 in respect to its export profits. Under the Indian Income Tax Act of 1961, substantially all of the earnings of the Company's Indian subsidiary are currently exempt from Indian Income Tax as profits are attributable to export operations. However, since management currently intends to repatriate all accumulated earnings from India to the United States, the Company has provided deferred U.S. income taxes on all such Indian undistributed earnings. Deferred U.S. income taxes on unremitted earnings from other foreign entities have not been provided for as it is the Company's intent to reinvest such earnings. Such income taxes are immaterial.
NET INCOME PER SHARE. Basic earnings per share ("EPS") excludes dilution and is computed by dividing earnings available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS includes all dilutive potential common stock in the weighted average shares outstanding. (See Note 8 to the Consolidated Financial Statements)
STOCK-BASED COMPENSATION. With respect to stock options granted to employees, SFAS No. 123 "Accounting for Stock-Based Compensation" permits companies to continue using the accounting method promulgated by the Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to Employees," to measure compensation or to adopt the fair value based method prescribed by SFAS No. 123. Management has decided to continue to use the provisions of APB 25 and not to adopt SFAS No. 123's accounting provisions, but has included the required pro forma disclosures.
RECLASSIFICATIONS. Certain prior-year amounts have been reclassified to conform with the 2001 presentation.
RECENTLY ISSUED ACCOUNTING STANDARDS. In June 2001, Statement of Financial Accounting Standards No. 141, "Business Combinations" ("FAS 141") and Statement of Financial Accounting Standards No. 142 "Goodwill and Other Intangible Assets" ("FAS 142") were issued. FAS 141 requires the purchase method of accounting to be used for all business combinations initiated after June 30, 2001. FAS 141 also specifies criteria that intangible assets acquired must meet to be recognized and reported separately from goodwill. The Company does not anticipate that adoption of FAS 141 will have any material effect on the Company's financial position or results of operations. FAS 142 requires that goodwill and intangible assets with indefinite lives no longer be amortized but instead be measured for impairment at least annually, or when events indicate that there may be an impairment. FAS 142 is effective for fiscal years beginning after December 15, 2001. The adoption of FAS 142 in the first quarter of 2002 will not have a material effect on the Company's financial position or results of operations.
In June 2001, Statement of Financial Accounting Standards No. 143, "Accounting for Asset Retirement Obligations" ("FAS 143") was issued. FAS 143 addresses financial accounting and reporting for legal obligations associated with the retirement of tangible long-lived assets and the associated retirement costs that result from the acquisition, construction, or development and normal operation of a long-lived asset. Upon initial recognition of a liability for an asset retirement obligation, FAS 143 requires an increase in the carrying amount of the related long-
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COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share data)
lived asset. The asset retirement cost is subsequently allocated to expense using a systematic and rational method over the assets useful life. FAS 143 is effective for fiscal years beginning after June 15, 2002. The adoption of this statement is not expected to have a material impact on the Company's financial position or results of operations.
In August 2001, Statement of Financial Standards No. 144, "Accounting for the Impairment or Disposal of Long-lived Assets" ("FAS 144") was issued. FAS 144 supersedes Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-lived Assets to be Disposed of," and the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently occurring Events and Transactions." FAS 144 also amends ARB ("Accounting Research Bulletins") No. 51, Consolidated Financial Statements, to eliminate the exception to consolidation for a subsidiary for which control is likely to be temporary. FAS 144 retains the fundamental provisions of FAS 121 for recognizing and measuring impairment losses on long-lived assets held for use and long-lived assets to be disposed of by sale, while resolving significant implementation issues associated with FAS 121. Among other things, FAS 144 provides guidance on how long-lived assets used as part of a group should be evaluated for impairment, establishes criteria for when long-lived assets are held for sale, and prescribes the accounting for long-lived assets that will be disposed of other than by sale. FAS 144 is effective for fiscal years beginning after December 15, 2001. The Company does not anticipate, that adoption of FAS 144 will have a material impact on the Company's financial position and results of operations.
3. INITIAL PUBLIC OFFERING
On June 24, 1998, the Company consummated its Initial Public Offering ("IPO") of 5,834,000 shares of its Common Stock at a price of $5.00 per share (on a post-split basis), 5,000,000 of which were issued and sold by the Company and 834,000 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 $22,407 after $843 of direct expenses. In July 1998, IMS Health (the accounting successor to Cognizant) sold 875,000 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 $6,637 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. (See Note 8 to the Consolidated Financial Statements.)
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COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share data)
4. SUPPLEMENTAL FINANCIAL DATA
PROPERTY AND EQUIPMENT
Property and equipment consist of the following:
ESTIMATED DECEMBER 31 USEFUL LIFE ----------- (YEARS) 2001 2000 ----------- ---- ----
Buildings....................... 40 $ 3,930 $ 1,544 Computer equipment and purchased software 3 27,160 18,106 Furniture and equipment......... 5 - 9 1,958 1,753 Land............................ 1,678 1,580 Leasehold improvements.......... Various 6,418 3,951 ------------ ---------- Sub-total..................... 41,144 26,934 Accumulated depreciation and amortization.................. (16,805) (10,997) ------------ ---------- Property and Equipment - Net........ $ 24,339 $ 15,937 ============ ==========
ACCRUED EXPENSES AND OTHER LIABILITIES
Accrued expenses and other current liabilities consist of the following:
DECEMBER 31, ------------ 2001 2000 ---- ----
Accrued compensation and benefits... $ 7,676 $ 10,056 Deferred revenue.................... 2,696 2,199 Accrued vacation 2,465 1,873 Accrued travel and entertainment.... 1,705 2,398 Accrued income taxes................ 0 1,446 Other............................... 3,504 5,368 ------------ ---------- $ 18,046 $ 23,865 ============ ==========
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COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share data)
5. INVESTMENT
In June 2000, the Company announced a strategic relationship with Trident Capital, a leading venture capital firm, to jointly invest in emerging e-business service and technology companies. In accordance with this strategy, the Company invested $1,955 in Questra Corporation, an e-business software and consulting firm headquartered in Rochester, New York, in return for a 5.8% equity interest. Trident Capital also independently made a direct investment in Questra Corporation. The Company's investment is being accounted for under the cost basis of accounting.
The Company reviews for impairment certain assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Questra Corporation recently issued Preferred B shares in exchange for $19 million of new venture capital financing. Since the Company did not participate, it's ownership interest in Preferred A shares was reduced from 5.8% to 2.1%. Based on the implied fair value of Questra, as measured by the latest round of financing, and considering the preferential liquidation rights that the Preferred B shareholders received, the Company has concluded that it will not recover its investment in Questra and has recorded an impairment loss of $1,955 to recognize the other than temporary decline in value of its investment.
6. EMPLOYEE BENEFITS
Beginning in 1997, certain U.S. employees of the Company were eligible to participate in Cognizant's and now IMS Health's 401(k) plan. The Company matches up to 50.0% of the eligible employee's contribution. The amount charged to expense for the Company's matching contribution was $0, $31 and $49 for the years ended December 31, 2001, 2000 and 1999, respectively. In 2000, the Company established a 401(k) plan, which certain U.S. employees of the Company became eligible to participate in. The Company matches up to 50.0% of the eligible employee's contribution. The amount charged to expense for the matching contribution was $351 and $195 for the years ended December 31, 2001 and 2000, respectively.
Certain of the Company's employees participate in IMS Health's defined benefit pension plan and a defined contribution plan in the United Kingdom sponsored by the Company. The costs to the Company recognized as postretirement benefit costs and related liabilities were not material to the Company's results of operations or financial position for the years presented. (See Note 10 to the Consolidated Financial Statements.)
CTS India maintains an employee benefit plan that covers substantially all India-based employees. The employees' provident fund, pension and family pension plans are statutory defined contribution retirement benefit plans. Under the plans, employees contribute up to twelve percent of their base compensation, which is matched by an equal contribution by CTS India. Contribution expense recognized was $790, $501 and $338 for the years ended December 31, 2001, 2000 and 1999, respectively.
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COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share data)
CTS India also maintains a statutory gratuity plan that is a statutory postemployment benefit plan providing defined lump sum benefits. CTS India makes annual contributions to an employees' gratuity fund established with a government-owned insurance corporation to fund a portion of the estimated obligation. The Company estimates its obligation based upon employees' salary and years of service. Expense recognized by the Company was $902, $511,and $358 for the years ended December 31, 2001, 2000 and 1999, respectively.
7. INCOME TAXES
Income (loss) before provision for income taxes consisted of the following for years ended December 31:
2001 2000 1999 ---- ---- ---- U.S.................................. $ 7,236 $ 7,469 $ 7,553 Non-U.S.............................. 28,163 20,778 10,392 -------- -------- -------- Total................................ $35,399 $28,247 $17,945 ======== ======== =======
The provision (benefit) for income taxes consists of the following for the years ended December 31:
2001 2000 1999 ---- ---- ---- U.S. Federal and state: Current.............................. $ 2,986 $ 3,276 $ 3,079 Deferred............................. 8,620 6,409 3,354 -------- -------- -------- Total U.S. Federal and state......... 11,606 9,685 6,433 -------- -------- -------- Non-U.S.: Current.............................. 1,466 961 315 Deferred............................. 167 (82) (37) -------- -------- -------- Total non-U.S........................ 1,633 879 278 -------- -------- -------- Total................................ $13,239 $10,564 $ 6,711 ======== ======== ========
The following table sets forth the significant differences between the U.S. federal statutory taxes and the Company's provision for income taxes for consolidated financial statement purposes:
2001 2000 1999 ---- ---- ---- Tax expense at U.S. Federal statutory rate...$ 12,390 $ 9,604 $ 6,101 State and local income taxes, net of Federal benefit........................... 361 375 398 Non-deductible Goodwill amortization......... 111 108 109 Other........................................ 377 477 103 --------- -------- ------- Total income taxes...........................$ 13,239 $10,564 $ 6,711 ========= ======== =======
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COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share data)
The Company's deferred tax assets (liabilities) are comprised of the following at December 31:
2001 2000 ---- ----
Deferred tax assets: Net operating losses $ -- $ 120 Timing differences.............................. 1,042 367
Net deferred tax assets........................... 1,042 487
Deferred tax liabilities: Undistributed Indian income..................... 25,535 17,189
Total deferred tax liabilities.................... 25,535 17,189 Net deferred tax liability........................ $24,493 $16,702
CTS India is an export oriented company that is entitled to claim a tax holiday for a period of nine years from April 1995 through March 2004 in respect to its export profits. Under the Indian Income Tax Act of 1961, substantially all of the earnings of the Company's Indian subsidiary are currently exempt from Indian Income Tax as profits are attributable to export operations. However, since management currently intends to repatriate all accumulated earnings from India to the United States, the Company has provided deferred U.S. income taxes on all such undistributed earnings. Deferred U.S. income taxes on unremitted earnings from other foreign entities have not been provided for as it is the Company's intent to reinvest such earnings. Such income taxes are not material. The Company has determined that the income taxes recorded by the Company would not be materially different in the absence of the current tax exemption and, therefore, the tax exemption had no material effect on earnings per share.
8. CAPITAL STOCK
A. COMMON STOCK. On June 12, 1998, the Company amended and restated its certificate of incorporation to authorize 100,000,000 shares of Class A common stock, par value $.01 per share, 15,000,000 shares of Class B common stock, par value $.01 per share, and 15,000,000 shares of preferred stock, par value $.10 per share, and effected a 0.65 for one reverse stock split. Holders of Class A common stock have one vote per share and holders of Class B common stock have ten votes per share. Holders of Class B common stock are entitled to convert their shares into Class A common stock at any time on a share for share basis. Shares of Class B Common Stock transferred to stockholders of IMS Health in a transaction intended to be on a tax-free basis (a "Tax-Free Spin-Off") under the Code shall not convert to shares of Class A Common Stock upon the occurrence of such Tax-Free Spin-Off. No preferred stock has been issued.
Subsequent to the IPO, the underwriters exercised their right to purchase an additional 875,100 shares of Class A Common Stock. As a result, IMS Health, the majority owner and controlling parent of the Company, converted 875,100 shares of Class B Common stock into Class A Common Stock and subsequently sold such shares.
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COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share data)
On February 11, 2000, the Board of Directors declared a 2-for-1 stock split of Class A and Class B Common Stock effected by a 100% dividend payable on March 16, 2000 to stockholders of record on March 2, 2000. The stock split has been reflected in the financial statements, and all applicable references to the number of outstanding common shares and per share information has been restated. Appropriate adjustments have been made in the exercise price and number of shares subject to stock options. Stockholders' equity account have been restated to reflect the reclassification of an amount equal to the par value of the increase in issued common shares from the capital in excess of par value account to the common stock accounts.
On May 23, 2000, the stockholders of the Company approved an increase in the number of authorized Class B common Stock from 15,000,000 shares to 25,000,000 shares.
B. REDEEMABLE COMMON STOCK. On July 25, 1997, certain management employees of the Company and its affiliates subscribed and subsequently purchased Common Stock under the "Key Employees Restricted Stock Purchase Plan." These shares were purchased by the employees at the then estimated fair market value of $1.93 per share. Holders of the stock may put, at any time, to the Company their shares at the lower of the purchase price or the share price based on a valuation of the Company at the time of the put. Upon consummation of the IPO, this put right terminated. The Company initially recorded the value of the purchased stock outside the equity section. In 1998, upon the completion of the initial public offering, all redemption conditions were removed, and the shares were reclassified to common stock.
9. EMPLOYEE STOCK OPTIONS PLANS
In July 1997, CTS adopted a Key Employees Stock Option Plan, which provides for the grant of up to 1,397,500 stock options to eligible employees. Options granted under this plan may not be granted at an exercise price less than fair market value of the underlying shares on the date of grant. As a result of the IPO, all options have a life of ten years, vest proportionally over four years and have an exercise price equal to the fair market value of the common stock on the grant date.
In December 1997, CTS adopted a Non-Employee Directors' Stock Option Plan, which provides for the grant of up to 143,000 stock options to eligible directors. Options granted under this plan may not be granted at an exercise price less than fair market value of the underlying shares on the date of grant. As a result of the IPO, all options have a life of ten years, vest proportionally over two years and have an exercise price equal to the fair market value of the common stock on the grant date.
In March 1998, CTS granted non-qualified stock options to purchase an aggregate of 97,500 shares to CTS's Chairman and Chief Executive Officer at an exercise price of $13.84 per share, an amount less than the then fair market value of the shares on the date of the grant. The Company has recorded the related compensation expense over the vesting period of these options.
In May 1999, CTS adopted the 1999 Incentive Compensation Plan, which provides for the grant of up to 2,000,000 stock options to eligible employees, nonemployee Directors and
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COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share data)
independent contractors. Options granted under this plan may not be granted at an exercise price less than fair market value of the underlying shares on the date of grant. All options have a life of ten years, vest proportionally over four years, unless specified otherwise, and have an exercise price equal to the fair market value of the common stock on the grant date. On May 23, 2000, the stockholders of the Company approved an increase in the number of shares available for issuance under this plan from 2,000,000 to 3,000,000 shares. On May 30, 2001, the stockholders of the Company approved an increase in the number of shares available for issuance under this plan from 3,000,000 to 6,000,000.
A summary of the Company's stock option activity, and related information is as follows as of December 31, 2001, 2000 and 1999:
The following summarizes information about the Company's stock options outstanding and exercisable by price range at December 31, 2001:
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COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share data)
Compensation cost recognized by the Company under APB 25 was $11, $35 and $172 for 2001, 2000 and 1999, respectively.
Had compensation cost for the Company's stock-based compensation plans, as well as the IMS Health options held by certain executive officers (See Note 10 to the Consolidated Financial Statements), been determined based on the fair value at the grant dates for awards under those plans, consistent with the method prescribed by SFAS No. 123, the Company's net income and net income per share would have been reduced to the pro forma amounts indicated below:
DECEMBER 31, ------------ 2001 2000 1999 ---- ---- ----
Net income As reported..................... $22,160 $17,683 $11,234 Pro forma....................... $15,033 $12,815 $10,047 As reported Net income per share, basic..... $1.17 $0.95 $0.61 Net income per share, diluted... $1.09 $0.87 $0.58 Pro forma Net income per share, basic..... $0.79 $0.69 $0.55 Net income per share, diluted... $0.74 $0.63 $0.52
The pro forma disclosures shown above are not representative of the effects on net income and earnings per share in future years.
For purposes of pro forma disclosures only, the fair value for all Company options was estimated at the date of grant using the Black-Scholes option model with the following weighted average assumptions in 2001; risk-free interest rate of 4.3%, expected dividend yield of 0.0%, expected volatility of 78% and weighted average expected life of 3.0 years. 2000 assumptions; risk-free interest rate of 6.1%, expected dividend yield of 0.0%, expected volatility of 75% and expected life of 3.9 years. 1999 assumptions; risk-free interest rate of 5.6 %, expected dividend yield of 0.0%, expected volatility of 75.0% and expected life of 3.9 years. The weighted-average fair value of the Company's options granted during 2001, 2000 and 1999 was $16.68, $21.71 and $7.45, respectively. The assumptions used in 1999 for IMS Health stock options were: risk-free interest rate of 4.8%, expected dividend yield of 0.3%, expected volatility of 35.0% and expected life of 3.0 years. The assumptions used in 1998 for IMS Health stock options were: risk-free interest rate of 5.5%, expected dividend yield of 0.3%, expected volatility of 25.0% and expected life of 3.0 years. The weighted average fair value of IMS Health stock options granted to certain executive officers in 1998 was $7.14 and in 1999 was $9.99.
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COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share data)
10. RELATED PARTY TRANSACTIONS AND TRANSACTIONS WITH AFFILIATES
REVENUES. The Company and IMS Health have entered into Master Services Agreements pursuant to which the Company provides IT services to IMS Health. In 2001, the Company recognized related party revenues totaling $18,809 including revenues from IMS Health. In 2000, the Company recognized related party revenues totaling $14,273 including revenues from IMS Health and Strategic Technologies (through August 30, 2000). In 1999, the Company recognized related party revenues totaling $14,820 including revenues from IMS Health and Strategic Technologies.
AFFILIATED AGREEMENTS. In 1997, the Company entered into various agreements with Cognizant which were assigned to IMS Health as part of the 1998 Reorganization. The agreements include an Intercompany Services Agreement for services provided by IMS Health such as payroll and payables processing, tax, real estate and risk management services, a License Agreement to use the "Cognizant" trade name and an Intercompany Agreement. On July 1, 1998, IMS Health transferred all of its rights to the "Cognizant" name and related trade and service marks to the Company.
SERVICES. IMS Health currently provides the Company with certain administrative services, including payroll and payables processing and permits the Company to participate in IMS Health's business insurance plans. In prior periods, IMS Health provided certain other services such as tax planning and compliance, which have now been transitioned to the Company. All services were performed under the CTS / IMS Health intercompany services agreement. Total costs charged to the Company by IMS Health in connection with these services were $440, $254 and $350 for the years ended December 31, 2001, 2000 and 1999, respectively.
In December 2001, the Company paid IMS Health a one-time fee of approximately $825 under an alliance agreement in which the Company was named "vendor of choice" for IT services to the pharmaceutical industry.
Intercompany receivables/payables to IMS Health at December 31, 2001, 2000 and 1999 are as follows:
2001 2000 1999 ---- ---- ---- Proceeds from (payments to), net..... - $8 $(24)
In addition, the Company has a certain relationship with the former Erisco Managed Care Technologies ("Erisco"), which is now a wholly owned subsidiary of The Trizetto Group, Inc. ("Trizetto"). As of December 31, 2001, IMS Health owned approximately 26.8% of the outstanding common stock of Trizetto. During 2001 the Company recorded revenues from
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COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share data)
Erisco of approximately $401 and payments to Erisco for commissions and marketing fees of approximately $1,012.
PENSION PLANS. Certain U.S. employees of the Company participate in IMS Health's defined benefit pension plans. The plans are cash balance pension plans under which six percent of creditable compensation plus interest is credited to the employee's retirement account on a monthly basis. The cash balance earns monthly investment credits based on the 30-year Treasury bond yield. At the time of retirement, the vested employee's account balance is actuarially converted into an annuity. The Company's cost for these plans is included in the allocation of expense from IMS Health for employee benefits plans.
STOCK OPTIONS. In November 1996, in consideration for services to the Company, Cognizant Corporation granted an executive officer and director of the Company options to purchase an aggregate of 114,900 shares (on a pre-split basis) of the common stock of Cognizant Corporation at an exercise price of $33.38 per share. Such executive officer and director agreed to forfeit options to purchase 58,334 shares (on a pre-split basis) of Cognizant Corporation common stock upon the consummation of the Company's initial public offering. In July 1998, IMS Health granted an executive officer options to purchase an aggregate of 8,158 shares (on a pre-split basis) of the common stock of IMS Health at an exercise price of $30.17 per share. All remaining such options have since been converted into options to purchase the common stock of IMS Health as a result of the Reorganization that occurred on July 1, 1998, the two-for-one split of IMS Health stock that occurred on January 15, 1999, the distribution of Gartner Group shares that occurred on July 26, 1999 and the distribution of Synavant Inc. (formerly known as Strategic Technologies) shares that occurred on August 30, 2000. At December 31, 2001 after adjusting for the Reorganization, the split of IMSH stock and the distribution of Gartner Group and Synavant Inc. shares, such officer had 143,687 options in IMS Health outstanding at a weighted average exercise price of $14.47 per share. At December 31, 2001, 127,470 options were exercisable.
In November 1996, Cognizant Corporation granted an executive officer options to purchase an aggregate of 60,000 shares (on a pre-split basis) of the common stock of Cognizant Corporation at an exercise price of $33.38 per share. In addition, in November 1996, such executive officer was granted options to purchase an aggregate of 20,000 shares (on a pre-split basis) of the common stock of Cognizant Corporation at an exercise price of $33.38 per share, which was equal to the fair market value at the grant date, by paying ten percent of the option exercise price as an advance payment toward such exercise. The unvested portion of such advance payment is refundable under certain conditions. The remaining 90 percent is payable at exercise. In July 1998, IMS Health granted an executive officer options to purchase an aggregate of 9,106 shares (on a pre-split basis) of the common stock of IMS Health at an exercise price of $30.17 per share. All remaining such options have since been converted into options to purchase the common stock of IMS Health as a result of the Reorganization, the two-for-one split of IMS Health stock, the distribution of Gartner Group and Synavant Inc. shares discussed above. At December 31, 2001, after adjusting for the Reorganization, the split of IMSH stock and the distribution of Gartner Group and Synavant Inc. shares, such officer had
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COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share data)
68,222 options in IMS Health outstanding at a weighted average exercise price of $17.07 per share. At December 31, 2001, 39,326 options were exercisable.
11. COMMITMENTS
As of December 31,2001, the Company has entered into fixed capital commitments related to its India development center expansion program of approximately $10.7 million, of which $7.6 million has been spent to date.
The Company leases office space and equipment under operating leases, which expire at various dates through the year 2010. Certain leases contain renewal provisions and generally require the Company to pay utilities, insurance, taxes, and other operating expenses. Future minimum rental payments under operating leases that have initial or remaining lease terms in excess of one year as of December 31, 2001 are as follows:
2002................................................... $4,761 2003................................................... 4,296 2004................................................... 2,819 2005................................................... 1,400 2006................................................... 785 Thereafter............................................. 2,033 Total minimum lease payments........................... $16,094
Rental expense totaled $3,175, $3,472, and $1,823 for years ended December 31, 2001, 2000 and 1999, respectively.
12. 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
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COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share data)
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, would have a material adverse effect on the Company's business, results of operations and financial condition.
13. SEGMENT INFORMATION
The Company, operating globally, provides software services for medium and large businesses. North American operations consist primarily of software services in the United States and Canada. European operations consist of software services principally in the United Kingdom. Asian operations consist of software services principally in India. The Company is managed on a geographic basis. Accordingly, regional sales managers, sales managers, account managers, project teams and facilities are segmented geographically and decisions by the Company's chief operating decision maker regarding the allocation of assets and assessment of performance are based on such geographic segmentation.
In accordance with SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information." Information about the Company's operations and total assets in North America, Europe and Asia for the years ended December 31, 2001, 2000 and 1999 are as follows:
2001 2000 1999 ---- ---- ---- REVENUES (1)(1a) North America (2)............... $ 152,422 $ 114,932 $ 71,171 Europe(3)....................... 23,092 20,959 17,352 Asia............................ 2,264 1,140 381 ---------- ---------- ---------- Consolidated.................... $ 177,778 $ 137,031 $ 88,904 ========== ========== ==========
OPERATING INCOME (1) North America(2)................ $ 30,536 $ 21,918 $ 13,328 Europe(3)....................... 4,632 3,994 3,245 Asia............................ 452 216 72 ---------- ---------- ------------ Consolidated.................... $ 35,620 $ 26,128 $ 16,645 ========== ========== ============
IDENTIFIABLE ASSETS North America(2)................ $ 88,328 $ 71,464 $ 43,671 Europe(4)....................... 5,322 7,293 3,408 Asia............................ 51,333 30,783 21,947 ---------- ---------- ------------ Consolidated.................... $ 144,983 $ 109,540 $ 69,026 ========== ========== ============
(1) Revenues and resulting operating income are attributed to regions based upon customer location.
(1a) Application development and integration services represented approximately 32.3%, 46.1% and 42.9% of revenues in 1999, 2000 and 2001, repsectively. Application management services accounted for 44.0%, 47.0% and 51.8% of revenues in 1999, 2000 and 2001, respectively. Year 2000 compliance services represented approximately 15.6% of revenues in 1999.
(2) Substantially all relates to operations in the United States.
(3) Includes revenue from operations in the United Kingdom of $18,129, $13,718, and $9,933 for the year ended December 31, 2001, 2000 and 1999, respectively.
(4) Includes identifiable assets in the United Kingdom of $5,184, $7,012, and $3,325 at December 31, 2001, 2000 and 1999, respectively.
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COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (in thousands, except share and per share data)
During 1999, 2000 and 2001, the Company's top five customers accounted for, in the aggregate, 57.3%, 39.5% and 34.7% of revenues, respectively. The Company's ten largest customers accounted for, in the aggregate, approximately 75.3%, 59.1% and 53.0% of the Company's revenues in 1999, 2000 and 2001, respectively. In 2001, sales to related party customers accounted for 10.6% of revenues. No third party customer accounted for sales in excess of 10% of revenues in 2000. In 2000, sales to related party customers accounted for 10.4% of revenues. No third party customer accounted for sales in excess of 10% of revenues in 2000. In 1999, sales to related party customers accounted for 16.7% of revenues and one third party customer accounted for 17.4% of revenues. 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.
QUARTERLY FINANCIAL DATA (UNAUDITED)
(1) The sum of the quarterly earnings per share does not equal full year earnings per share due to rounding.
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Cognizant Technology Solutions Corporation Valuation and Qualifying Accounts (Dollars in Thousands)
Accounts Receivable Allowance:
Balance at Charged to Charged to Beginning of Costs and Other Balance at Year Period Expenses Accounts Deductions End of Period ---- ------- -------- -------- ---------- ------------- 2001 $ 516 $ 1,895 -- $ 1,529 $ 882
2000 $ 225 $ 572 -- $ 281 $ 516
1999 $ 274 $ (31) -- $ 18 $ 225
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