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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
Commission file number 0-24429
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
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(Exact Name of Registrant as Specified In Its Charter)
Delaware 13-3728359
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(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
500 Glenpointe Centre West, Teaneck, New Jersey 07666*
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(Address of Principal Executive Offices) (Zip Code)
(201) 801-0233
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(Registrant's Telephone
Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
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Securities registered pursuant to Section 12(g) of the Act:
Class A Common Stock, par value $0.01 per share
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Class B Common Stock, par value $0.01 per share
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* On January 1, 1999, the Registrant relocated its principal executive office
from 1700 Broadway, 26th Floor, New York, New York 10019 to 500 Glenpointe
Centre West, Teaneck, New Jersey 07666.
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes: X No:
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. X
State the aggregate market value of the voting and non-voting common equity
held by non-affiliates of the Registrant: $143,218,423 at February 26, 1999
based on the last sales price on that date.
Indicate the number of shares outstanding of each of the Registrant's
classes of common stock, as of February 26, 1999:
Class Number of Shares
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Class A Common Stock, par value $0.01 per share 3,506,411
Class B Common Stock, par value $0.01 per share 5,645,450
The following documents are incorporated by reference into the Annual
Report on Form 10-K: Portions of the Registrant's definitive Proxy Statement for
its 1999 Annual Meeting of Stockholders are incorporated by reference into Part
III of this Report.
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TABLE OF CONTENTS
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Item Page
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PART I 1. Business................................................4
2. Properties.............................................14
3. Legal Proceedings......................................14
4. Submission of Matters to a Vote of Security Holders....15
PART II 5. Market for the Company's Common Equity
and Related Stockholder Matters........................16
6. Selected Consolidated Financial Data...................18
7. Management's Discussion and Analysis of
Financial Condition and Results of Operations .........19
8. Financial Statements and Supplementary Data............28
9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure.................28
PART III 10. Directors and Executive Officers of the Company........29
11. Executive Compensation.................................29
12. Security Ownership of Certain Beneficial Owners
and Management.........................................29
13. Certain Relationships and Related Transactions.........29
PART IV 14. Exhibits, Financial Statement Schedule,
and Reports on Form 8-K................................30
SIGNATURES...............................................................31
EXHIBIT INDEX............................................................33
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS..............................F-1
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PART I
ITEM 1. BUSINESS.
GENERAL
Cognizant Technology Solutions Corporation ("CTS" or the "Company")
delivers high-quality, cost-effective, full life cycle solutions to complex
information technology software development and technology maintenance problems
through the use of a seamless on-site and offshore consulting project team.
These solutions include application development and maintenance services, Year
2000 and Eurocurrency compliance services, testing and quality assurance
services and re-hosting and re-engineering services. The Company provides
world-class service to its customers through an integrated business model that
combines a technical and account management team located on-site at the customer
location and seven development centers located in India.
The Company markets and sells its technology consulting services directly
through its professional staff, senior management and direct sales personnel
operating out of its Teaneck, New Jersey headquarters and its regional offices,
as well as through independent sales agents. The number of customers for whom
the Company has provided services has grown from 27 customers in 1997 to 40
customers in 1998. The Company's customers include ACNielsen Corporation
("ACNielsen"), Aetna Canada, CCC Information Services Incorporated, IMS Health
Incorporated ("IMS Health"), The Dun & Bradstreet Corporation, First Data
Corporation, GEAC Computer Systems Incorporated ("GEAC"), Guaranty National
Corporation, Nielsen Media Research, Inc. ("Nielsen Media Research"), and
Northwest Airlines, Inc.
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 November 1996, the Company,
Erisco, Inc., IMS International Inc., Nielsen Media Research, Pilot Software,
Inc., Sales Technologies, Inc., and certain other entities, plus a majority
interest in Gartner Group Inc., were spun-off from The Dun & Bradstreet
Corporation to form Cognizant Corporation ("Cognizant"), the then majority owner
and controlling parent of the Company. At that time, ACNielsen was separately
spun-off from The Dun & Bradstreet Corporation and Dun & Bradstreet Software was
sold to GEAC. 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.
On January 15, 1998, Cognizant announced that it would, subject to certain
conditions, reorganize itself, by spinning the Nielsen Media Research business
from the rest of its businesses, creating two publicly traded companies, 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.
On June 19, 1998, the Company effected its initial public offering ("IPO")
of 2,917,000 shares of its Class A Common Stock, par value $0.01 per share
(3,354,550 shares including the
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underwriters' over-allotment option). Of such shares, 2,500,000 were offered by
the Company and 417,000 shares were offered by the Company's then majority owner
and controlling parent, Cognizant Corporation (accounting predecessor to IMS
Health). At December 31, 1998, IMS Health owned approximately 61.7% of the
outstanding stock of the Company and held approximately 94.2% of the combined
voting power of the Company's Common Stock. In 1997, the Company entered into
various agreements with Cognizant which were assigned to IMS Health as part of
the 1998 spin-off. The agreements include an Intercompany Services Agreement for
services provided by IMS Health such as payroll and payables processing, tax,
finance, personnel administration, 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.
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 is one critical way to achieve these objectives. At the
same time, the pace of technology evolution has accelerated and companies are
increasingly adopting emerging technologies, such as client/server
architectures, data warehousing, Internet/intranet applications and
object-oriented development in order to remain competitive. Although these
emerging technologies offer the promise of faster, more functional and more
flexible IT systems, their implementation presents major challenges and requires
a large number of highly skilled individuals trained in many diverse
technologies and architectures. In addition, companies also require additional
technical resources to maintain their large legacy systems and to address Year
2000 and Eurocurrency compliance issues.
Many companies have made the strategic decision to focus on their core
competencies and reduce their cost structures rather than invest in the large IT
staffs that are necessary to evaluate, implement and manage IT initiatives.
Consequently, these companies have turned to IT service providers both to
develop and implement new IT solutions and to maintain legacy 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, such as India, which is widely acknowledged as a leader in
offshore software development. 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 as application
development 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 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. Additionally, service providers utilizing offshore workforces must
continually
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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
The Company delivers high-quality, cost-effective, full life cycle
solutions to complex software development and maintenance problems through the
use of a seamless on-site and offshore project team. These solutions include
application development and maintenance services, Year 2000 and Eurocurrency
compliance services, testing and quality assurance services and re-hosting and
re-engineering services. The Company provides world-class service to its
customers through an integrated business model which combines a technical and
account management team located on-site at the customer location and seven
development centers located in India. To support this business model, the
Company has recruited and trained in excess of 1,500 programmers in India and
put in place well developed facilities, technology and communications
infrastructure. By basing its technical operations in India, the Company has
access to a large pool of skilled, English-speaking IT professionals with which
to service customers on a cost basis significantly lower than in developed
countries. The main elements of the CTS solution, which the Company believes
differentiate it from other IT service providers, include the following:
Established and Scaleable Proprietary Processes. To facilitate the
cost-effective, on-time delivery of high-quality projects integrating an on-site
and offshore team, the Company has developed proprietary methodologies
encapsulated in its 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 every
project, QView is used to make an extensive front-end assessment defining the
scope and risks of the project and to 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 its quality process, the Company assigns a quality
facilitator to each project who 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 the Company's processes and methodologies.
The Company's processes and methodologies have proven to be scaleable as the
Company has increased its number of offshore development centers, customers and
projects. Recently, the Company was assessed at Level 4 of the Capability
Maturity Model by 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 and
ensuring that they are versed in the Company's processes and methodologies,
particularly the QView software engineering process. The Company has over 100
project managers and senior technical personnel on its worldwide staff, many of
whom have significant work experience in the United States. The Company's
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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, to hire the best available
technical professionals and to train these professionals in both legacy systems
and emerging technologies, as well as the Company's software development and
quality processes. The Company provides five months of combined classroom and
on-the-job training to new hires and additional training each year to
continually enhance the business practices, tools, technology and consulting
skills of its professional staff.
Full Range of Technologies. The Company has project experience and
expertise across multiple architectures and technologies, including emerging
technologies such as data warehousing, Internet/intranet applications and
object-oriented development. Because most of the Company's programmers are
trained in multiple technologies and architectures, the Company is able to react
to customers' needs and quickly redeploy programmers to new technologies. In
addition, through its internal research and development activities and the
continuing education of its technical personnel, the Company assures that its
collective skillset keeps pace with emerging technologies. The ability to work
in new technologies allows the Company to address the needs of its customers and
to develop new and foster existing long-term relationships.
Well Developed Infrastructure. The Company's extensive facilities,
technology and communications infrastructure facilitates the seamless
integration of its on-site and offshore workforces by permitting team members in
different locations to access common project information and to work directly on
customer projects. This infrastructure allows for rapid completion of projects,
off-peak utilization of customers' technological resources and 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
software development and maintenance services utilizing an on-site and offshore
model. 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 customers and
business partners and to leverage these relationships into additional project
opportunities. For example, the Company is using its Year 2000 compliance
expertise to establish relationships with new customers. The Company believes
that the knowledge of customers' systems gained during the performance of Year
2000 compliance services provides 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 by the Company in the development process.
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Extend Service Offerings and Solutions. The Company has a team dedicated to
developing new service offerings in emerging technologies and also collaborates
with its customers to develop such offerings. For example, the Company has
recently undertaken Eurocurrency compliance projects and is developing
proprietary solutions using data warehousing and Internet/intranet technology.
To facilitate the development of new solutions, the Company conducts internal
research and development and promotes knowledge building and sharing across the
organization. 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.
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 currently is designing and
developing new 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 Geographic Presence. As the Company expands its customer base, it
plans to open additional sales and marketing offices in the United States to
enable it to sell to and support existing and prospective customers. During
1998, sales and marketing offices in Chicago and San Francisco were opened. In
addition, the Company has been pursuing market opportunities in Europe through
its U.K. office which was established in the beginning of 1998.
Pursue Selective Strategic Acquisitions. The Company believes that
opportunities exist in the fragmented IT services market to expand its business
through selective strategic acquisitions. The Company believes that acquisition
candidates may enable it to expand its geographic presence, enter new technology
areas or expand capacity.
SERVICES
The Company provides a broad range of software services, including: (i)
application development; (ii) application maintenance support; (iii) Year 2000
compliance; (iv) Eurocurrency compliance; (v) testing and quality assurance; and
(vi) re-hosting and re-engineering. The Company's range of services enable it to
meet customer needs for systems development/integration, application management
and mass change implementation. 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.
Service Summary Description of Service Offerings
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Application Development............... Define requirements, write specifications
and design, develop and test software.
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Application Maintenance Support...... Support some or all of a customer's
applications ensuring that systems remain
operational and responsive to changing
user requirements.
Year 2000 Compliance................. Renovate applications to correctly process
dates in the next century, including
impact analysis, code conversion, testing
and implementation.
Eurocurrency Compliance...............Renovate applications to correctly process
transactions which are denominated in
Eurocurrency, as well as existing
currencies.
Testing and Quality Assurance.........Test source and/or binary code to verify
that it conforms to specifications and
compatibility requirements.
Re-hosting and Re-engineering.........Modify and test applications to enable
systems to function in new operating
environments.
Application Development Services. The Company develops new applications for
IBM mainframe, client/server architectures and other emerging technology
environments. The Company follows either of two alternative approaches,
including (i) full life cycle application development, in which the Company
assumes total start-to-finish responsibility and accountability for analysis,
design, implementation and testing of systems, or (ii) cooperative development,
in which the Company's employees work with a customer's in-house IT personnel to
jointly analyze, design, implement and test 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
seven 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.
Application Maintenance Support Services. The Company provides services to
ensure that a customer's legacy software systems are operational and responsive
to end-users' changing needs. In doing so, the Company is often able to
introduce process enhancements and improve service levels to customers
requesting modifications and on-going support.
Through its 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.
Routine maintenance services, including modifications, enhancements and
documentation, which typically have longer turn around times, are completed
offshore utilizing satellite telecommunications and the resources of the
Company's software development centers.
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Year 2000 Compliance Services. With the year 2000 approaching, computer
software systems that were not designed to correctly process dates in the next
century are expected to fail. Organizations rely on mission-critical software
systems and must either repair the problem presented by the Year 2000 issue or
replace legacy systems.
The Company uses its proprietary Year 2000 toolset and methodology, Century
Transition Services 2000, to provide a cost-effective total technology solution
for all phases of a Year 2000 compliance project. The Century Transition
Services 2000 methodology covers the entire life cycle of a Year 2000 compliance
project, and is comprised of a seven step process: (i) inventory preparation;
(ii) impact analysis; (iii) strategy and design; (iv) code change and data
migration; (v) unit, system and acceptance testing; (vi) implementation; and
(vii) post-implementation support. The Company believes that it differentiates
itself from its competitors through the use of its Century Transition Services
2000.
The Century Transition Services 2000 toolset covers a wide array of common
programming languages and environments including many client/server
environments. This toolset is capable of identifying Year 2000 problems in
COBOL, Model 204, SAS, Mark IV, CLIST, REXX, PL/1, IBM Mainframe Assembler,
TELON, JCL and other languages. In the midrange and client/server environment,
the Company's toolset addresses, among other languages, C, C+ +, Visual Basic,
PowerBuilder, Sybase, MS-Office (Word, Excel, Access), Oracle, Informix,
Paradox, Clipper, FoxPro and Lotus Notes. The Company is thus able to provide
complete solutions across a large portion of customers' systems.
Eurocurrency Compliance Services. The monetary union of the European
Community presents a significant opportunity for the Company as computer
systems, which deal with any European denominated currency need to be modified
to handle local currency and Eurocurrency transactions. Based on the current
schedule for European monetary unification, non-cash Euro transactions started
on January 1, 1999, bank notes and coins will start circulating on January 1,
2002 and national currencies will be withdrawn by July 1, 2002. The Company has
established a dedicated practice to focus on the Eurocurrency compliance
problem.
Testing and Quality Assurance Services. Testing and quality assurance is a
critical aspect of any software development activity. The Company works with
customers to better define the quality assurance processes which are in use by
the customers' in-house IT departments. The Company utilizes its quality
assurance expertise, based on its QView software engineering process, to ensure
better quality software through fundamental process improvements.
The Company also advises certain customers, principally independent
software vendors, on testing applications which may or may not have been
developed by the Company. Various types of testing services such as top-down,
bottom-up, black-box/white-box, unit, integration and system testing are
provided by a large offshore team in a short time, with minimal impact on
product release. Defect tracking is automated by a CTS-developed tool that
ensures that all detected defects are tracked to closure.
Re-Hosting and Re-Engineering Services. Through the Company's re-hosting
and 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
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architectures. The Company's re-engineering tools automate many of the processes
required to implement advanced client/server technologies, thereby substantially
reducing 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 re-design and convert user interfaces.
CUSTOMERS
The Company provided services to a total of 11, 27 and 40 customers in
1996, 1997 and 1998, respectively. During 1996, 1997 and 1998, the Company's top
five customers accounted for 97.6%, 77.5% and 60.5% of revenues, respectively.
During 1996, 1997 and 1998, IMS Health and its current subsidiaries accounted
for 15.7%, 23.7% and 18.0% of revenues, respectively. 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. The Company's ten largest customers accounted for, in the
aggregate, approximately 99.9%, 92.3% and 81.0% of its revenues in 1996, 1997
and 1998, respectively. In 1996, The Dun & Bradstreet Corporation accounted for
more than 75.0% of revenue. In 1997, Cognizant Corporation and ACNielsen
accounted for more than 40.0% and 10.0% of revenues, respectively. In 1998, IMS
Health, First Data Corporation and ACNielsen each accounted for more than 10.0%
of revenue. Approximately 26.4%, 44.4% and 44.1% of the Company's revenues were
derived from Year 2000 compliance services in 1996, 1997 and 1998, respectively.
Application development services represented approximately 20.9%, 19.4% and
25.8% of the Company's revenues in 1996, 1997 and 1998, respectively.
Application maintenance services accounted for 44.2%, 28.4% and 21.1% of the
Company's revenues in 1996, 1997 and 1998, respectively.
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
Chicago, San Francisco, Toronto and London. At December 31, 1998, the Company
had ten direct sales persons, 29 account managers and five independent sales
agents. 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 define the scope,
deliverables, assumptions and execution strategies for a proposed project,
develop project estimates, prepare pricing and margin analyses and finalize
sales proposals. Management reviews and approves the proposal, which is 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. The Company also
generates a portion of its business through outside agents, who work on a
commission basis. In
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this regard, account managers play an important role in helping to develop a
long-term relationship with customers. 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 highly competitive. This market includes participants
from a variety of market segments, including systems integration firms, contract
programming companies, application software companies, the professional services
groups of computer equipment companies, facilities management and outsourcing
companies and "Big Five" accounting firms, as well as smaller local competitors
in the various geographic markets in which the Company operates. The Company
competes with, among others, Alydaar Corp., Cambridge Technology Partners, Inc.,
Cap Gemini America, Inc., Complete Business Solutions, Inc., Computer Horizons
Corp., Computer Task Group, Inc., CSC Consulting, Information Management
Resources, Inc., Infosys, Inc., IBM Global Services, Keane, Inc., Mastech
Corporation, Satyam Computer Services Limited, SHL Systemhouse (a division of
MCI Communications Corporation), Syntel, Inc., Tata Consultancy Services and
Whittman-Hart, Inc. 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,
thereby increasing 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
the Company. The principal competitive factors affecting the markets for the
Company's services include (i) performance and reliability, (ii) quality of
technical support, training and services, (iii) responsiveness to customer
needs, (iv) reputation, experience and financial stability and (v) competitive
pricing of services. The Company competes by offering a well developed
recruiting, training and retention model, a successful service delivery model,
an excellent referral base, continual investment in process improvement and
knowledge capture, and 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, and its
failure to do so could have a material adverse effect upon the Company's
business, results of operations and financial condition.
INTELLECTUAL PROPERTY
The Company's consulting business includes the development of software
applications and other technology deliverables including 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, and 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 its copyrights.
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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 its intellectual property, or that the Company will
be able to detect unauthorized use and take appropriate steps to enforce its
rights.
Pursuant to the License Agreement between the Company and IMS Health (the
"License Agreement"), Cognizant Corporation granted to the Company a
non-exclusive, nonassignable, revocable license to use the "Cognizant" name and
certain related trade and service marks. On July 1, 1998 Cognizant Corporation
transferred all of its rights to the "Cognizant" name and related trade and
service marks to the Company. See also Item 3. Legal Proceedings.
EMPLOYEES
At December 31, 1998, the Company employed approximately 325 persons on a
full-time basis in its North American headquarters and satellite offices and
on-site North American customer locations (19 of whom are United States citizens
or permanent residents), approximately 65 persons on a full-time basis in its
European satellite office and on-site European customer locations and
approximately 1,170 persons on a full-time basis in its offshore software
development centers in India. As of December 31, 1998, approximately 290, or
94.0% of the Company's employees working in the United States, were working in
the H-1B, nonimmigrant work-permitted visa classification. None of the Company's
employees is subject to a collective bargaining arrangement. The Company
considers its relations with its employees to be good.
The future success of the Company depends to a significant extent on its
ability to attract, train and retain highly skilled software development
professionals, particularly 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 and has developed a recruiting system and database
that facilitates the rapid identification of skilled candidates. During the
course of the year, the Company visits approximately 45 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,
which 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 the Company's services.
-13-
ITEM 2. PROPERTIES.
The Company's executive and business development office is located in
Teaneck, New Jersey. The Company's lease in New York, for its prior executive
office space, was terminated at January 1, 1999 at no cost to the Company. The
Company believes that its existing facilities are adequate to support its
existing operations and that, as needed, it will be able to obtain suitable
additional facilities on commercially reasonable terms.
The Company occupies the following properties, which are all leased:
Approximate
Location Area Use Nature of Occupancy
(in sq. feet)
- --------------------------------------------------------------------------------
Chennai, India 49,200 Software Multiple leases expiring
Development Facility 2/1/06-12/15/06 with
renewal options
Chennai, India 35,100 Software Multiple leases expiring
Development Facility 3/31/03-5/1/06 with
renewal options
Chennai, India 20,000 Software Lease expiring 8/1/04
Development Facility with a renewal option
Calcutta, India 13,900 Software Lease expiring 10/7/07
Development Facility with a renewal option
Pune, India 11,500 Software Lease expiring 7/10/07
Development Facility with a renewal option
Calcutta, India 9,300 Software Lease expiring 11/1/00
Development Facility with a renewal option
Calcutta, India 4,000 Software Multiple Leases expiring
Development Facility 5/1/99-1/25/00 with
renewal options
Teaneck, New Jersey 9,700 Executive and Lease expiring 5/31/02
Business
Development Office
Chicago, Illinois 2,000 Business Lease expiring 10/15/00
Development Office
San Francisco, 500 Business Lease expiring 1/31/99
California Development Office
London, England 800 Business Monthly lease
Development Office
Toronto, Canada 200 Business Lease expiring 1/31/99
Development Office
ITEM 3. LEGAL PROCEEDINGS.
The Company has received correspondence from legal counsel representing a
company called Cognizant Design Group of Incline Village, Nevada ("CDG")
alleging infringement by the Company of CDG's purportedly prior rights to the
name "Cognizant." CDG demanded that the Company, among other things, refrain
from further use of the name "Cognizant" in the future. The Company is
investigating the claims made by CDG and, if appropriate, intends to seek a
-14-
mutually satisfactory resolution. There can be no assurance, however, that such
a resolution will be obtained on terms satisfactory to the Company or that CDG
will not commence litigation against the Company. If such litigation is
commenced there can be no assurance that there will be an outcome favorable to
the Company.
There is no other material litigation to which the Company is a party or to
which any of its property is subject.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
Not applicable.
-15-
PART II
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 but shall no longer be convertible into shares
of Class A Common Stock at the option of the holder. 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
-16-
Revenue Service challenge such automatic conversion as violating the 80.0% vote
requirement currently required by the Code for a Tax-Free Spin-Off.
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 June 30, 1998 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
-------------------------- ------------ -----------
June 30, 1998........... $12 7/8 $ 9 1/2
(from June 19, 1998)
September 30, 1998...... $19 5/8 $11 9/16
December 31, 1998....... $33 1/2 $ 7
As of February 22, 1999, the approximate number of holders of record of the
Class A Common Stock was 17 and the approximate number of beneficial holders of
the Class A Common Stock was 2,225.
As of February 22, 1999, all of the outstanding Class B Common Stock of the
Company was owned by IMS Health.
The Company has never declared or paid 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 anticipate paying
any cash dividends in the foreseeable future.
-17-
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,
1997 and 1998 and for each of the three years in the period ended December 31,
1998 are derived from the audited financial statements included elsewhere
herein. The selected consolidated financial data set forth below for the Company
as of December 31, 1994, 1995 and 1996 and for each of the years ended December
31, 1994 and 1995 are derived from the audited financial statements not included
elsewhere herein. The selected consolidated financial information for 1996, 1997
and 1998 should be read in conjunction with the Consolidated Financial
Statements and the Notes and "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations" which are included elsewhere in
this Annual Report on Form 10-K.
YEAR ENDED DECEMBER 31,
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
(in thousands, except per share data)
STATEMENTS OF INCOME DATA:
Revenues.................. $ -- $ 298 $ 2,775 $13,898 $45,031
Revenues - related party.. 1,687 6,877 9,257 10,846 13,575
------ ------ ------ ------ ------
Total revenues......... 1,687 7,175 12,032 24,744 58,606
Cost of revenues.......... 534 3,567 6,020 14,359 31,919
------ ------ ------ ------ ------
Gross profit.............. 1,153 3,608 6,012 10,385 26,687
Selling, general and
administrative expenses.. 1,351 2,213 3,727 6,898 15,547
Depreciation and
amortization expense..... 65 376 819 1,358 2,222
------ ------ ------ ------ ------
Income (loss) from
operations............... (263) 1,019 1,466 2,129 8,918
Other income:
Interest income........ 4 7 8 25 638
Other income - net..... (19) 44 1 -- 83
------ ------ ------ ------ ------
Total other income..... (15) 51 9 25 721
------ ------ ------ ------ ------
Income before provision
for income taxes......... (278) 1,070 1,475 2,154 9,639
Provision for income
taxes.................... 105 (247) (341) (581) (3,606)
Minority interest......... (22) (362) (492) (545) -
Net income................ $ (195) $ 461 $ 642 $ 1,028 $ 6,033
====== ====== ====== ====== ======
Basic earnings per share.. $ (0.03) $ 0.07 $ 0.10 $ 0.16 $ 0.76
====== ====== ====== ====== ======
Diluted earnings per
share.................... $ (0.03) $ 0.07 $ 0.10 $ 0.16 $ 0.73
====== ====== ====== ====== ======
Weighted average number
of common shares
outstanding.............. 6,500 6,500 6,500 6,547 7,943
====== ====== ====== ====== ======
Weighted average number
of common shares and
stock options
outstanding.............. 6,500 6,500 6,500 6,605 8,269
====== ====== ====== ====== ======
BALANCE SHEET DATA
(at period end):
Cash and cash equivalents. $ 174 $ 546 $ 1,810 $ 2,715 $28,418
Working capital........... 305 1,126 2,781 5,694 29,416
Total assets.............. 1,824 5,451 7,827 18,298 51,679
Due to related party...... 690 662 976 6,646 9
Stockholders' equity...... 408 1,766 2,806 3,419 32,616
-18-
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
GENERAL
The Company delivers full life cycle software development and maintenance
technology consulting services to its customers through the use of a seamless
on-site and offshore project team. These services include application
development and maintenance services, Year 2000 and Eurocurrency compliance
services, testing and quality assurance services and re-hosting and
re-engineering services.
The Company began its software development and maintenance services
business in early 1994, as an in-house technology development center for The Dun
& Bradstreet Corporation and its operating units. In 1996, the Company, Erisco,
Inc. ("Erisco"), IMS International Inc. ("IMS"), Nielsen Media Research, Inc.,
Pilot Software Inc. and Sales Technologies, Inc. and certain other entities,
plus a majority interest in Gartner Group, Inc. were spun-off from The Dun &
Bradstreet Corporation to form Cognizant. In 1997, the Company purchased the
24.0% minority interest in its Indian subsidiary from a third party for $3.4
million, making the Indian subsidiary wholly owned by the Company. In June 1998,
the Company completed its IPO. On June 30, 1998, a majority interest in the
Company, Erisco, IMS and certain other entities were spun-off from Cognizant to
form IMS Health. At December 31, 1998, IMS Health owned approximately 61.7% of
the outstanding stock of the Company and held approximately 94.2% of the
combined voting power of the Company's Common Stock. During 1996, the Company
made a strategic decision to attract customers that were not affiliated with
Cognizant or any of the former affiliates of The Dun & Bradstreet Corporation.
As a result, sales from customers not currently or previously affiliated with
The Dun & Bradstreet Corporation, Cognizant, IMS Health, and any of their
respective subsidiaries grew from $1.3 million, or 11.2% of revenues, in 1996 to
$6.5 million, or 26.3% of revenues, in 1997 and $26.9 million, or 46.0% of
revenues, in 1998.
Approximately 88.8%, 73.7% and 54.0% of the Company's revenues in 1996,
1997 and 1998, respectively, were generated from current and former affiliates
of the Company including approximately 15.7%, 23.7% and 18.0%, respectively,
from IMS Health and its current subsidiaries. In addition, 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 1996,
1997 and 1998, the Company's five largest customers (other than IMS Health and
its current subsidiaries) accounted for 80.7%, 50.8% and 43.7% of revenues,
respectively. In 1996, The Dun & Bradstreet Corporation accounted for more than
75.0% of revenue. In 1997, Cognizant Corporation and ACNielsen accounted for
more than 40.0% and 10.0% of revenues, respectively. In 1998, IMS Health, First
Data Corporation and ACNielsen each accounted for more than 10.0% of revenue.
The volume of work performed for IMS Health and its subsidiaries and other
customers is likely to vary from year to year, and a major customer, whether
affiliated or unaffiliated, in one year may not provide the same level of
revenues in any subsequent year.
Approximately 26.4%, 44.4% and 44.1% of the Company's revenues were derived
from Year 2000 compliance services in 1996, 1997 and 1998, respectively.
Application development services represented approximately 20.9%, 19.4% and
25.8% of the Company's revenues in 1996,
-19-
1997 and 1998, respectively. Application maintenance services accounted for
44.2%, 28.4% and 21.1% of the Company's revenues in 1996, 1997 and 1998,
respectively.
The Company's services are performed on either a time-and-materials or
fixed-price basis. The Company expects that an increasing number of its future
projects will be fixed-price rather than time-and-materials (which has
historically been the basis for its contracts). Revenues related to
time-and-materials contracts are recognized as the service is performed.
Revenues related to fixed-price contracts are recognized using the
percentage-of-completion method of accounting, under which the sales value of
performance, including earnings thereon, is recognized on the basis of the
percentage that each contract's cost to date bears to the total estimated cost.
Estimates are subject to adjustment as a project progresses to reflect changes
in expected completion costs. The cumulative impact of any revision in estimates
of the percentage of work completed is reflected in the financial reporting
period in which the change in the estimate becomes known, and any anticipated
losses are recognized immediately. Since the Company bears the risk of cost
over-runs and inflation associated with fixed-price projects, the Company's
operating results may be adversely affected by changes in estimates of contract
completion costs.
The majority of the Company's revenues are earned within North America.
Revenues outside of North America totaled $2.4 million, $3.5 million and $10.7
million in 1996, 1997 and 1998, respectively. Revenues from customers located
outside of North America have historically been generated primarily in the
United Kingdom and Germany. As a percentage of revenues, revenues outside of
North America represented 19.9%, 14.3% and 18.3% in 1996, 1997 and 1998,
respectively. The primary denomination for invoices issued by the Company is
U.S. dollars, with the exception of invoices issued in Canada and the United
Kingdom which 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 results of operation.
-20-
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,
----------------------------------------
1996 1997 1998
------------ ------------ ------------
Total revenues....................... 100.0% 100.0% 100.0%
Cost of revenues..................... 50.0 58.0 54.5
------ ----- ------
Gross profit...................... 50.0 42.0 45.5
Selling, general and administrative
expenses.......................... 31.0 27.8 26.5
Depreciation and amortization
expense........................... 6.8 5.6 3.8
------ ----- ------
Income from operations............ 12.2 8.6 15.2
Other income (expense):
Interest income................... 0.1 0.1 1.1
Other income (expense)............ -- -- 0.1
------ ----- ------
Total other income (expense)......... 0.1 0.1 1.2
Income before provision for
income taxes...................... 12.3 8.7 16.4
Provision for income taxes........... (2.8) (2.3) (6.2)
Minority interest.................... (4.1) (2.2) --
------ ----- ------
Net income........................... 5.3% 4.2% 10.3%
====== ===== ======
-21-
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Revenue. Revenue increased by 136.8%, or $33.9 million, from $24.7 million
in 1997 to $58.6 million in 1998. This increase included $14.9 million of
increased Year 2000 compliance services, and $19.0 million of increased sales of
software development, maintenance and Eurocurrency compliance services. Revenue
growth resulted, in part, from the successful implementation of the Company's
Year 2000 rollover strategy, pursuant to which Year 2000 clients have been
converted to include non-Year 2000 assignments including software development
and maintenance. The percentage of revenues from unrelated parties increased
from 56.2% in 1997 to 76.8% in 1998. This increase resulted primarily from the
Company's continued efforts to pursue unaffiliated third-party customers and the
impact of the spin-off in June 1998 of a majority interest in the Company,
Erisco, IMS and certain other entities to form IMS Health, and the establishment
of Nielsen Media Research as a separate publicly traded company. 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. Accordingly, as of July 1, 1998, Nielsen Media Research was no longer
deemed to be a related party.
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 122.3%, or $17.6 million, from $14.4 million in
1997 to $31.9 million in 1998. The increase was due primarily to the increased
cost resulting from the increase in the number of the Company's technical
professionals from approximately 900 employees at December 31, 1997 to
approximately 1,400 employees at December 31, 1998. The Company's gross profit
increased by 157.0%, or approximately $16.3 million, from approximately $10.4
million in 1997 to approximately $26.7 million in 1998. Gross profit margin
increased from 42.0% of revenues in 1997 to 45.5% of revenues in 1998. The
increase in gross profit margin was primarily attributable to the increased
third party revenue which have higher margins and a higher utilization level of
technical professionals during 1998 compared to 1997.
Selling, general and administrative expenses. Selling, general and
administrative expenses consist primarily of salaries, employee benefits,
travel, promotion, communications, management, finance, administrative and
occupancy costs. Selling, general and administrative expenses, including
depreciation and amortization, increased by 115.2%, or $9.5 million, from $8.3
million in 1997 to $17.8 million in 1998, but decreased as a percentage of
revenue from 33.4% to 30.3%, respectively. The increase in such expenses in
absolute dollars was primarily due to expenses incurred to expand the Company's
sales and marketing activities and increased infrastructure expenses to support
the Company's revenue growth. The Company expects selling, general and
administrative expenses to continue to increase in absolute dollars to support
the Company's expansion. The decrease in selling, general and administrative
expenses as a percentage of revenue resulted from the Company's continued
ability to leverage the significant investments it made in the beginning of 1997
to establish a sales and marketing organization and to create the infrastructure
necessary to operate as an independent company.
Income from Operations. Income from operations increased 318.9% or $6.8
million, from $2.1 million in 1997 to $8.9 million in 1998, representing 8.6%
and 15.2% of revenues, respectively. The increase in operating margin was
primarily due to the increased third-party
-22-
revenue which generally has higher margins and the higher utilization level of
technical professionals mentioned above.
Other Income. Other income consists primarily of interest income and
foreign currency exchange gains. Interest income increased by $613,000 from
$25,000 in 1997 to $638,000 in 1998. The increase in such interest income was
attributable primarily to increased interest income resulting from the
investment of the net proceeds generated from the Company's IPO and generally
higher cash balances. The Company recognized a net foreign currency exchange
gain of $83,000 in 1998, as a result of the effect of changing exchange rates on
the Company's transactions.
Provision for Income Taxes. Historically, the Company had been included in
the consolidated federal income tax returns of The Dun & Bradstreet Corporation
and Cognizant. The Company's provision for income taxes in the consolidated
statements of income reflects federal and state income taxes calculated on the
Company's stand alone basis. The provision for income taxes increased from
$581,000 in 1997 to $3.6 million in 1998 resulting in an effective tax rate of
27.0% in 1997 and 37.4% in 1998. Without the effect of minority interest, the
effective tax rate would have been approximately 35.0% in 1997.
Minority Interest. In 1997, minority interest expense was $545,000. This
expense was attributable to profitability of the Company's Indian subsidiary in
which an unaffiliated third party held a 24.0% minority interest. The Company
purchased the minority interest in October 1997 for $3.4 million. The Company
has not recognized any minority expense subsequent to such purchase. In 1997 and
1998 the Company recorded $76,000 and $317,000 of amortization expense,
respectively, in connection with the goodwill recorded on the acquisition of the
remaining portion of its Indian subsidiary.
Net Income. Net income increased from $1.0 million in 1997 to $6.0 million
in 1998, representing 4.2% and 10.3% as a percentage of revenues, respectively.
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Revenue. The Company's revenues increased 105.7% from $12.0 million in 1996
to $24.7 million in 1997. This increase included $7.8 million of increased sales
of Year 2000 compliance services, and $4.9 million of increased sales of
software development and maintenance services. The percentage of revenues from
unrelated parties increased from 23.1% or $2.8 million in 1996 to 56.2% or $13.9
million in 1997. This increase resulted from the full-year impact in 1997 of the
fourth quarter 1996 spin-off of Cognizant (including the Company) from The Dun &
Bradstreet Corporation, as well as the Company's expanded efforts to pursue
unaffiliated third-party 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.
Gross profit. Gross profit increased 72.7% from $6.0 million in 1996 to
$10.4 million in 1997. As a percentage of revenues, gross profit declined from
50.0% in 1996 to 42.0% in 1997. Cost of revenues increased 138.5% from $6.0
million in 1996 to $14.4 million in 1997. The increase in cost of revenues was
primarily attributable to increases in the number of the Company's technical
professionals from approximately 500 employees at December 31, 1996 to
-23-
approximately 900 employees at December 31, 1997. The increase in cost of
revenues as a percentage of revenues resulted primarily from a movement in the
mix of programmers from offshore to on-site locations, which resulted in higher
labor rates and lower gross margins.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased 81.6% from $4.5 million in 1996 to $8.3
million in 1997. This increase included $2.3 million in increased sales and
marketing expenses and $1.4 million in increased infrastructure expenses to
support the Company's revenue growth as the Company opened its fourth
development center in India. As a percentage of revenues, selling, general and
administrative expense declined from 37.8% in 1996 to 33.4% in 1997.
Income from Operations. Income from operations increased 45.2% from $1.5
million in 1996 to $2.1 million in 1997, representing 12.2% and 8.6% of
revenues, respectively. The decrease in operating margin was primarily due to
the Company's investment in its expanding sales and marketing infrastructure to
support its strategy of continued pursuit of third-party customers and, to a
lesser extent, the movement in the mix of project staff from offshore to on-site
locations.
Provision for Income Taxes. The provision for income taxes increased 70.4%
from $341,000 in 1996 to $581,000 in 1997, resulting in an effective tax rate of
23.1% in 1996 and 27.0% in 1997. Without the effect of minority interest, the
effective tax rate would have been approximately 35.0% for both periods.
Minority Interest. In 1996, minority interest expense was $492,000 compared
to $545,000 in 1997. The increase in absolute dollars was attributable to
increased profitability of the Company's Indian subsidiary in which a third
party held the 24.0% minority interest offset by the effect on the income
statement of the purchase of such minority interest in October 1997 for $3.4
million. The Company has not recognized any minority interest expense subsequent
to such purchase.
Net Income. Net income was $642,000 in 1996 as compared to $1.0 million in
1997, representing 5.3% and 4.2% as a percentage of revenues, respectively.
BACKLOG
The Company generally enters into written contracts with its customers at
the time it commences work on a project. These written contracts contain varying
terms and conditions and the Company does not generally believe it is
appropriate to characterize such written contracts as creating backlog.
Additionally, because these written contracts often provide that the arrangement
can be terminated with limited advance notice and without penalty, the Company
does not believe that projects in progress at any one time are a reliable
indicator or measure of expected future revenue.
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company's primary sources of funding had been cash flow
from operations and intercompany cash transfers with its majority owner and
controlling parent company IMS Health, accounting successor to Cognizant. In
June 1998, the Company consummated its IPO of 2,917,000 shares of its Class A
Common Stock at a price to the public of
-24-
$10.00 per share, of which 2,500,000 shares were issued and sold by the Company
and 417,000 shares were sold, at that time, by Cognizant. In July 1998, IMS
Health (the accounting successor to Cognizant) sold 437,550 shares of Class B
Common Stock pursuant to an over allotment option granted to the underwriters of
the IPO. The net proceeds to the Company from the offering were approximately
$22.4 million after $845,000 of direct expenses. The funds received by the
Company from the IPO were invested in short-term, investment grade, interest
bearing securities, after the Company used a portion of the net proceeds to
repay approximately $6.6 million of non-trade related party balances to
Cognizant. The Company expects to use the remainder of the net proceeds from the
offering for (i) expansion of existing operations, including the Company's
offshore software development centers; (ii) continued development of new service
lines and possible acquisitions of related businesses; and (iii) general
corporate purposes including working capital.
Net cash provided by operating activities was approximately $13.3 million
during the year ended 1998 as compared to net cash provided by operating
activities of $1.7 million during the year ended 1997. The increase results
primarily from a higher level of accrued liabilities, increased net income, and
an increase in deferred taxes, partially offset by increased other current
assets. Accounts receivable increased from $7.4 million at December 31, 1997 to
$11.1 million at December 31, 1998. The increase in accounts receivable was due
primarily to the Company's increase in revenue partially offset by improved
collection efforts and results. The Company monitors turnover, aging and the
collection of accounts receivable through the use of management reports which
are prepared on a customer basis and evaluated by the Company's finance staff.
The Company's investing activities used net cash of $3.7 million for the
year ended December 31, 1998 as compared to net cash used of $6.4 million for
the year ended December 31, 1997. The decrease in 1998 of net cash used in
investing activities compared to 1997 primarily reflects the payment in 1997 for
the acquisition of the minority interest of the Company's Indian subsidiary.
The Company's financing activities provided net cash of $16.1 million for
the year ended December 31, 1998 as compared to $5.7 million for the year ended
December 31, 1997. The increase in 1998 compared to 1997 resulted primarily from
the net proceeds generated from the IPO of $22.4 million, offset by the
repayment of non-trade related party balances of approximately $6.6 million.
As of December 31, 1998, the Company had no significant third-party debt.
The Company had working capital of $29.4 million at December 31, 1998 and
$5.7 million at December 31, 1997.
The Company believes that its available funds and the cash flows expected
to be generated from operations, will be adequate to satisfy its current and
planned operations and needs for the next 12 months.
FOREIGN CURRENCY TRANSLATION
The assets and liabilities of the Company's Canadian and European
subsidiaries are translated into U.S. dollars at current exchange rates and
revenues and expenses are translated at average monthly exchange rates. The
resulting translation adjustments are recorded in a separate
-25-
component of stockholders' equity. For the Company's Indian subsidiary, the
functional currency is the U.S. dollar since its sales are made primarily in the
United States, the sales price is predominantly in U.S. dollars and there is a
high volume of intercompany transactions denominated in U.S. dollars between the
Indian subsidiary and its U.S. affiliates. Non-monetary assets and liabilities
are translated at historical exchange rates, while monetary assets and
liabilities are translated at current exchange rates. A portion of the Company's
costs in India are denominated in local currency and subject to exchange
fluctuations, which have not had any material adverse effect on the Company's
results of operations.
EFFECTS OF INFLATION
The Company's most significant costs are the salaries and related benefits
for its programming staff and other professionals. Competition in India and the
United States for professionals with advanced technical skills necessary to
perform the services offered by the Company have caused wages to increase at a
rate greater than the general rate of inflation. As with other IT service
providers, the Company must adequately anticipate wage increases, particularly
on its fixed-price contracts. There can be no assurance that the Company will be
able to recover cost increases through increases in the prices that it charges
for its services in the United States and elsewhere.
RISKS ASSOCIATED WITH THE YEAR 2000
Historically, certain computer programs have been written using two digits
rather than four to define the applicable year, which could result in the
computer recognizing a date using "00" as the year 1900 rather than 2000. This
in turn, could result in major system failures or miscalculations, and is
generally referred to as the "Year 2000 Problem". The Company believes that it
has sufficiently assessed its state of readiness with respect to its Year 2000
compliance. As the assessment was completed using internal personnel, costs and
time for such personnel were not specifically tracked. The Company, however,
estimates that such costs were immaterial. There were no external costs incurred
by the Company relating to its Year 2000 assessment. Costs incurred to date to
address the Year 2000 problem have been immaterial and the Company does not
believe that Year 2000 compliance will result in material investments by the
Company in the future. The Company does not anticipate that the Year 2000
Problem will have any material adverse effects on the business operations or
financial performance of the Company. The Company does not believe that it has
any material exposure to the Year 2000 Problem with respect to its own
information systems and believes that all of its business-critical systems
correctly define the Year 2000 and subsequent years. There can be no assurance,
however, that the Year 2000 Problem will not adversely affect the Company's
business, operating results and financial condition.
Contingency planning is underway in all of the Company's operations. These
plans will address facilities and equipment, telecommunications infrastructure,
and internal administrative processes. In addition, these plans will take into
account human resource and communications issues that relate to the Company's
employees. By the end of June 1999, the Company expects to have such contingency
plans in place to address the most likely effects on the Company from external
risks. As more information emerges about services upon which the Company is
critically reliant, these plans will be adjusted accordingly.
-26-
The purchasing patterns of customers and potential customers may be
affected by issues associated with the Year 2000 Problem. As companies expend
significant resources to correct their current data storage solutions, these
expenditures may result in reduced funds to undertake projects such as those
offered by the Company. There can be no assurance that the Year 2000 Problem
will not adversely affect the Company's business, operating results and
financial condition. Conversely, the Year 2000 Problem may cause other companies
to accelerate purchases, thereby causing an increase in short-term demand and a
consequent decrease in long-term demand for the Company's services.
RECENT ACCOUNTING PRONOUNCEMENTS
During 1998, 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, both in the United States and India;
(iv) the Company's limited operating history with unaffiliated customers; (v)
the Company's reliance on key customers and large projects; (vi) the highly
competitive nature of the markets for the Company's services; (vii) the
Company's ability to successfully address the continuing changes in information
technology, evolving industry standards and changing customer objectives and
preferences; (viii) the Company's reliance on the continued services of its key
executive officers and leading technical personnel; (ix) the
-27-
Company's ability to attract and retain a sufficient number of highly skilled
employees in the future; (x) the Company's ability to protect its intellectual
property rights; (xi) general economic conditions; (xii) year 2000 compliance of
vendors' products and related issues, including impact of the year 2000 problem
on customer buying patterns; and (xiii) the outcome of the impact of Year 2000
on the Company. The Company's actual results may differ materially from the
results disclosed in such forward-looking statements.
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. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
Not applicable.
-28-
PART III
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
1999 Annual Meeting of Stockholders is incorporated herein by reference to such
proxy statement.
ITEM 11. EXECUTIVE COMPENSATION.
The discussion under the heading "Executive Compensation" in the Company's
definitive proxy statement for the 1999 Annual Meeting of Stockholders is
incorporated herein by reference to such proxy statement.
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 1999
Annual Meeting of Stockholders is incorporated herein by reference to such proxy
statement.
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 1999 Annual
Meeting of Stockholders is incorporated herein by reference to such proxy
statement.
-29-
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K.
(a) (1) Financial Statements.
Reference is made to the Index to Consolidated Financial Statements
on Page F-1.
(a) (2) Financial Statement Schedule.
Reference is made to the Index to Financial Statement Schedule on
Page F-1.
(a) (3) Exhibits.
Reference is made to the Index to Exhibits on Page 33.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the quarter ended December
31, 1998.
Schedules other than the one 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.
-30-
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 19th day of March,
1999.
COGNIZANT TECHNOLOGY SOLUTIONS
CORPORATION
By:/s/Wijeyaraj Mahadeva
-------------------------------
Wijeyaraj Mahadeva, Chairman of the
Board and Chief Executive Officer
-31-
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.
Signature Title Date
--------- ----- ----
/s/Wijeyaraj Mahadeva Chairman of the Board and March 19, 1999
- ----------------------
Wijeyaraj Mahadeva Chief Executive Officer
(Principal Executive
Officer)
/s/Gordon Coburn Chief Financial Officer, March 19, 1999
- ----------------------
Gordon Coburn Treasurer and Secretary
(Principal Financial and
Accounting Officer)
/s/Anthony Bellomo Director March 19, 1999
- ----------------------
Anthony Bellomo
/s/Paul Cosgrave Director March 19, 1999
- ----------------------
Paul Cosgrave
Director
- ----------------------
Victoria Fash
/s/John Klein Director March 19, 1999
- ----------------------
John Klein
/s/Venetia Kontogouris Director March 19, 1999
- ----------------------
Venetia Kontogouris
-32-
EXHIBIT INDEX
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
- ------------ -----------------------
3.1 Amended and Restated Certificate of Incorporation.
(Incorporated by reference to Exhibit 3.1 to the
Company's Registration Statement on Form S-1 (File
Number 333-49783) which became effective on June 18,
1998.)
3.2 By-laws. (Incorporated by reference to Exhibit 3.2 to
the Company's Registration Statement on Form S-1 (File
Number 333-49783) which became effective on June 18,
1998.)
10.1* Form of Indemnification Agreement for Directors and
Officers. (Incorporated by reference to Exhibit 10.1 to
the Company's Registration Statement on Form S-1 (File
Number 333-49783) which became effective on June 18,
1998.)
10.2* Amended and Restated Cognizant Technology Solutions Key
Employees' Stock Option Plan. (Incorporated by reference
to Exhibit 10.2 to the Company's Registration Statement
on Form S-1 (File Number 333-49783) which became
effective on June 18, 1998.)
10.3* Amended and Restated Cognizant Technology Solutions
Non-Employee Directors' Stock Option Plan.
(Incorporated by reference to Exhibit 10.3 to the
Company's Registration Statement on Form S-1 (File
Number 333-49783) which became effective on June 18,
1998.)
10.4* Option Agreement between the Company and Wijeyaraj
Mahadeva. (Incorporated by reference to Exhibit 10.4 to
the Company's Registration Statement on Form S-1 (File
Number 333-49783) which became effective on June 18,
1998.)
10.5* Form of Master Services Agreement between the Company
and each of I.M.S. International, Inc., IMS America,
Ltd. and Nielsen Media Research, Inc. (Incorporated by
reference to Exhibit 10.5 to the Company's Registration
Statement on Form S-1 (File Number 333-49783) which
became effective on June 18, 1998.)
10.6* License Agreement between the Company and Cognizant
Corporation. (Incorporated by reference to Exhibit 10.6
to the Company's Registration Statement on Form S-1
(File Number 333-49783) which became effective on June
18, 1998.)
10.7* Intercompany Agreement between the Company and Cognizant
Corporation. (Incorporated by reference to Exhibit 10.7
to the Company's Registration Statement on Form S-1
(File Number 333-49783) which became effective on June
18, 1998.)
-33-
EXHIBIT
NO. DESCRIPTION OF EXHIBIT
- ------------ -----------------------
10.8* Intercompany Services Agreement between the Company and
Cognizant Corporation. (Incorporated by reference to
Exhibit 10.8 to the Company's Registration Statement on
Form S-1 (File Number 333-49783) which became effective
on June 18, 1998.)
10.9* Form of Severance and Non-Competition Agreement between
the Company and each of its Executive Officers.
(Incorporated by reference to Exhibit 10.9 to the
Company's Registration Statement on Form S-1 (File
Number 333-49783) which became effective on June 18,
1998.)
10.10** Sublease dated August 28, 1998 by and between Trans Tec
Services, Inc., as Sublessor, and the Company, as
Sublessee.
21 List of subsidiaries of the Company. (Incorporated by
reference to Exhibit 21 to the Company's Registration
Statement on Form S-1 (File Number 333-49783) which
became effective on June 18, 1998.)
23** Consent of PricewaterhouseCoopers LLP.
27** Financial Data Schedule.
- ------------------
* 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.
-34-
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENTS SCHEDULE
Page
----
Consolidated Financial Statements:
Report of Independent Accountants.......................................F-2
Consolidated Statements of Financial Position as of
December 31, 1997 and 1998............................................F-3
Consolidated Statements of Operations for the
years ended December 31, 1996, 1997 and 1998..........................F-4
Consolidated Statements of Stockholders'
Equity for the years ended
December 31, 1996, 1997 and 1998......................................F-5
Consolidated Statements of Cash Flows for the
years ended December 31, 1996, 1997 and 1998..........................F-6
Notes to Consolidated Financial Statements..............................F-7
Unaudited Quarterly Financial Data........................................F-23
Financial Statement Schedule
Schedule of Valuation and Qualifying Accounts...........................F-24
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
The Board of Directors and Stockholders
Cognizant Technology Solutions Corporation:
In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a)(1) on page 30 present fairly, in all material
respects, the financial position of Cognizant Technology Solutions Corporation
as of December 31, 1998 and 1997, and the results of their operations and their
cash flows for each of the three years in the period ended December 31, 1998, in
conformity with generally accepted accounting principles. In addition, in our
opinion, the financial statement schedule listed in the index appearing under
Item 14(a)(2) on page 30 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 generally accepted auditing standards 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 the opinion expressed above.
PricewaterhouseCoopers LLP
New York, New York
February 26, 1999
F-2
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
(in thousands, except par values)
AT DECEMBER 31,
---------------
1998 1997
---- ----
ASSETS
Current assets
Cash and cash equivalents................................... $28,418 $ 2,715
Trade accounts receivable, net of allowances of $274 and
$239, respectively........................................ 9,230 4,733
Trade accounts receivable - related party................... 1,877 2,670
Unbilled accounts receivable................................ 1,088 210
Other current assets........................................ 1,754 568
------- ------
Total current assets...................................... 42,367 10,896
------- ------
Property and equipment - net................................ 6,270 4,453
Goodwill, net............................................... 1,830 2,147
Other assets................................................ 1,212 802
------- ------
Total assets.............................................. $51,679 $18,298
======= ======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable............................................ $ 1,744 $ 1,543
Accrued and other liabilities............................... 11,207 3,659
------- -----
Total current liabilities................................. 12,951 5,202
Deferred income taxes....................................... 6,103 2,593
Due to related party........................................ 9 6,646
Minority interest........................................... -- --
------- ------
Total liabilities......................................... 19,063 14,441
------- ------
Commitments and contingencies
Mandatorily redeemable common stock (none issued and
outstanding at December 31, 1998 and 114 shares at
December 31, 1997)........................................ -- 438
------- ------
Stockholders' equity:
Preferred stock, $.10 par value, 15,000 shares authorized,
none issued............................................... -- --
Class A common stock, $.01 par value, 100,000 shares
authorized, 3,505 shares and 417 shares issued and
outstanding at December 31, 1998 and 1997, respectively... 35 4
Class B common stock, $.01 par value, 15,000 shares
authorized, 5,645 shares and 6,083 shares issued and
outstanding at December 31, 1998 and 1997, respectively... 57 61
Additional paid-in capital.................................. 24,566 1,420
Retained earnings........................................... 7,969 1,936
Cumulative translation adjustment........................... (11) (2)
-------- ------
Total stockholders' equity................................ 32,616 3,419
------- ------
Total liabilities and stockholders' equity................ $51,679 $18,298
====== ======
The accompanying notes are an integral part of the consolidated financial
statements.
F-3
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Years Ended December 31,
1998 1997 1996
---- ---- ----
Revenues......................................... $45,031 $13,898 $2,775
Revenues-related party........................... 13,575 10,846 9,257
-------- -------- -------
Total revenues................................. 58,606 24,744 12,032
Cost of revenues................................. 31,919 14,359 6,020
--------- -------- ------
Gross profit..................................... 26,687 10,385 6,012
Selling, general and administrative expense...... 15,547 6,898 3,727
Depreciation and amortization expense............ 2,222 1,358 819
-------- -------- -------
Income from operations........................... 8,918 2,129 1,466
Other income:
Interest income.................................. 638 25 8
-------- -------- -------
Other income, net................................ 83 -- 1
-------- -------- -------
Total other income............................. 721 25 9
Income before provision for income taxes......... 9,639 2,154 1,475
Provision for income taxes....................... (3,606) (581) (341)
Minority interest................................ -- (545) (492)
-------- -------- -------
Net income....................................... $6,033 $1,028 $ 642
======== ======== =======
Net income per share, basic...................... $0.76 $0.16 $0.10
======== ======== =======
Net income per share, diluted.................... $0.73 $0.16 $0.10
======== ======== =======
Weighted average number of common shares
outstanding - Basic............................ 7,943 6,547 6,500
======== ======== =======
Dilutive Effect of Shares Issuable as of
Period-End Under Stock Option Plans............ 302 58 --
======== ======== =======
Adjustment of Shares Applicable to Exercised
Stock Options during the Period................ 24 -- --
======== ======== =======
Weighted average number of common shares -
Diluted......................................... 8,269 6,605 6,500
======== ======== =======
Comprehensive Income:
Net income..................................... $6,033 $1,028 $ 642
Foreign currency translation adjustment........ (9) (2) --
-------- -------- -------
Total comprehensive income....................... $6,024 $1,026 $ 642
======== ======== =======
The accompanying notes are an integral part of the consolidated financial
statements.
F-4
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(in thousands)
Class A Class B Additional Retained Cumulative
Common Stock Common Stock Paid-in Earnings/ Translation Total
------------ ------------ -----
Capital (Deficit) Adjustment
------- --------- -----------
Shares Amount Shares Amount
------ ------ ------ ------
Balance, December 31, 1995.. 417 $ 4 6,083 $ 61 $ 1,435 $ 266 $ -- $ 1,766
Net transfers (to) from
related party.............. -- -- -- -- 398 -- -- 398
Net income.................. -- -- -- -- -- 642 -- 642
---- ---- ------ ---- ------- ------- ----- -------
Balance, December 31, 1996.. 417 4 6,083 61 1,833 908 -- 2,806
Net transfers (to) from
related party.............. -- -- -- -- (413) -- -- (413)
Translation adjustment...... -- -- -- -- -- -- (2) (2)
Net income.................. -- -- -- -- -- 1,028 -- 1,028
---- ---- ------ ---- ------- ------- ----- -------
Balance, December 31, 1997.. 417 4 6,083 61 1,420 1,936 (2) 3,419
Net transfers (to) from
related party.............. -- -- -- -- 62 -- -- 62
Translation adjustment ..... -- -- -- -- -- -- (9) (9)
Net Proceeds from IPO/
Issued Shares.............. 2,613 27 -- -- 22,818 -- -- 22,845
Exercise of Overallotment
Stock...................... 438 4 (438) (4) -- -- -- --
Exercise of Stock Options... 37 -- -- -- 144 -- -- 144
Compensatory Grant.......... -- -- -- -- 248 -- -- 248
Less Unearned portion...... -- -- -- -- (126) -- -- (126)
Net income ................. -- -- -- -- -- 6,033 -- 6,033
---- ---- ------ ---- ------- ------- ----- -------
Balance, December 31, 1998.. 3,505 $ 35 5,645 $ 57 $24,566 $ 7,969 $ (11) $32,616
===== ==== ====== ==== ======= ======= ======= =======
The accompanying notes are an integral part of the consolidated financial statements.
F-5
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended December 31,
1998 1997 1996
---- ---- ----
Cash flows from operating activities:
Net income................................. $6,033 $1,028 $ 642
Adjustments to reconcile net income to net
cash provided by Operating activities:
Depreciation and amortization............ 2,222 1,358 819
Provision for doubtful accounts.......... 45 239 --
Deferred income taxes.................... 3,510 1,170 518
Minority interest........................ -- 545 492
Changes in assets and liabilities:
Accounts receivable........................ (3,959) (4,933) (440)
Other current assets....................... (1,854) (591) 37
Other assets............................... (410) (390) (199)
Accounts payable........................... 201 842 (474)
Accrued and other liabilities.............. 7,548 2,386 487
Other adjustments for non-cash items....... 22 2 --
-------- -------- --------
Net cash provided by operating activities.. 13,358 1,656 1,882
-------- -------- --------
Cash flows used in investing activities:
Purchase of property and equipment......... (3,743) (3,025) (1,329)
Payment for acquisition of minority
interest in subsidiary................... -- (3,418) --
-------- -------- --------
Net cash (used in) investing activities.... (3,743) (6,443) (1,329)
Cash flows from financing activities:
Proceeds from Initial Public Offering...... 23,250 -- --
Costs associated with Initial Public
Offering................................. (843) -- --
Proceeds from option exercises/
compensatory grant/contributed capital... 327 25 397
Payments to/proceeds from related party
prior to the IPO......................... (6,637) 5,669 315
-------- -------- --------
Net cash provided by financing activities.. 16,097 5,694 712
Effect of Currency Translation............. (9) (2) --
Increase in cash and cash equivalents...... 25,703 905 1,265
Cash and cash equivalents, at beginning
of year.................................. 2,715 1,810 545
--------- -------- --------
Cash and cash equivalents, at end of year.. $ 28,418 $ 2,715 $ 1,810
========= ======== ========
Supplemental information:
Cash paid for income taxes during the year. $ 53 $ 158 $ 32
========= ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
F-6
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except share and per share data)
1. BASIS OF PRESENTATION
The Company is principally engaged in the software development and
maintenance consulting services business with operations and subsidiaries in
India, the United Kingdom, Canada and the United States. It delivers services to
customers, principally in the United States, through an on-site and offshore
project team. These information technology consulting services include
application development and maintenance services, Year 2000 and Eurocurrency
compliance services, testing and quality assurance services and re-hosting and
re-engineering services.
The Company is a Delaware corporation originally organized in 1988. The
Company began its software development and maintenance services business in
early 1994, as an in-house technology development center for The Dun &
Bradstreet Corporation and its operating units. In 1996, the Company, Erisco,
Inc. ("Erisco"), IMS International Inc. ("IMS"), Nielsen Media Research, Inc.,
Pilot Software Inc. and Sales Technologies, Inc. and certain other entities,
plus a majority interest in Gartner Group, Inc. were spun-off from The Dun &
Bradstreet Corporation to form Cognizant Corporation ("Cognizant"). In 1997, the
Company purchased the 24.0% minority interest in its Indian subsidiary from a
third party for $3.4 million, making the Indian subsidiary wholly owned by the
Company. In June 1998, the Company completed its IPO. On June 30, 1998, a
majority interest in the Company, Erisco, IMS and certain other entities were
spun-off from Cognizant to form IMS Health Incorporated ("IMS Health"), the
"accounting successor" to Cognizant, the Company's majority owner and
controlling parent company.
IMS Health currently provides the Company with certain administrative
services, including payroll and payables processing, e-mail, tax planning and
compliance, and permitted the Company to participate in IMS Health's insurance
and employee benefit plans. Costs for these services for all periods prior to
the IPO were allocated to the Company based on utilization of certain specific
services. All subsequent services were performed under the CTS IMS Health
intercompany services agreement. (See also Note 10. to the Consolidated
Financial Statements.)
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.
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.
F-7
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except share and per share data)
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.
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 is
recorded using the straight-line method over a period of seven years.
Amortization expense was $317 and $76 as of December 31, 1998 and 1997,
respectively. At each balance sheet date, the Company reviews the recoverability
of goodwill by comparing the unamortized balance to the related anticipated
undiscounted future cash flows from operating activities. It is the Company's
policy to recognize any anticipated under-recovery of goodwill as a result of
this review.
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 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. 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 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 ("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.
F-8
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except share and per share data)
Risks and Uncertainties. The preparation of financial statements in accordance
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and 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, depreciation of fixed
assets and long-lived assets 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 and assets, 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. A significant portion of the Company's current engagements
are for the Company's Year 2000 compliance projects. An unanticipated decline in
the demand for Year 2000 compliance services could have a material adverse
effect on the Company's business, results of operations and financial condition.
The Company believes that demand for Year 2000 compliance services will
diminish after the year 2000, as many solutions are implemented and tested. A
core element of the Company's strategy is to use the business relationships and
the knowledge of its customers' computer systems obtained in providing Year 2000
services to generate additional projects from these customers. There can be no
assurance that the Company will be successful in generating demand for other
services from its Year 2000 customers.
Net Income Per Share. In 1997, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 128, "Earnings Per Share," which replaces the
presentation of primary net income (loss) per share ("EPS") and fully diluted
EPS with a presentation of basic EPS and diluted EPS, respectively. Basic 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. Similar to fully diluted EPS, diluted EPS includes all dilutive
potential common stock in the weighted average shares outstanding.
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 and cash equivalents with high credit quality financial institutions.
F-9
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except share and per share data)
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 The Dun & Bradstreet Corporation. 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 The Dun & Bradstreet Corporation 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 year end 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 will be 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.
CTS India is an export oriented company that is entitled to claim a tax
holiday for a period of five years from April 1996 through March 2001 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 intends to repatriate all accumulated earnings from India to
the United States, the Company has provided deferred U.S. income taxes on all
undistributed earnings.
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 determined not to
adopt the SFAS No. 123's accounting recognition provisions, but has included
the required pro forma disclosures.
Reclassification. Certain prior-year amounts have been reclassified to conform
with the 1998 presentation.
Recently Issued Accounting Standards. In March 1998, the American Institute of
Certified Public Accountants (the "AICPA") issued Statement of Position ("SOP")
98-1, "Accounting For The Costs of Computer Software Developed Or Obtained For
Internal Use." SOP 98-1 provides guidance on costs to be capitalized and when
capitalization of such costs should commence. SOP 98-1 applies to costs incurred
after adoption, including costs for software projects that are in progress at
the time of the adoption. The Company has evaluated the impact of this SOP on
its financial position and results of operations and will implement SOP 98-1
effective January 1, 1999. The adoption of this pronouncement will not have a
material effect on the Company's financial statements.
F-10
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except share and per share data)
In April 1998, the AICPA issued SOP 98-5, "Accounting For The Costs Of
Start-up Activities." SOP 98-5 requires all costs of start-up activities to be
expensed as incurred. SOP 98-5 is effective for financial statements for the
years beginning after December 15, 1998. The adoption of this pronouncement will
not have a material effect on the Company's financial statements.
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, "Accounting For Derivative Instruments and Hedging Activities". SFAS
No. 133 is effective for all fiscal quarters for all fiscal years beginning
after June 15, 1999 (January 1, 2000 for the company). SFAS No. 133 requires
that all derivative instruments be recorded on the balance sheet at their fair
value. Changes in the fair value of derivatives are recorded each period in
current earnings or other comprehensive income, depending on whether a
derivative is designated as part of a hedge transaction and, if it is, the type
of hedge transaction. For fair-value hedge transactions in which the Company is
hedging changes in an asset's, liability's, or firm commitment's fair value,
changes in the fair value of the derivative instrument will generally be offset
in the income statement by changes in the hedged item's fair value. For
cash-flow hedge transactions, in which the Company is hedging the variability of
cash flows related to a variable-rate asset, liability or a forecasted
transaction, changes in the fair value of the derivative instrument will be
reported in other comprehensive income. The gains and losses on the derivative
instrument that are reported in other comprehensive income will be reclassified
as earnings in the periods in which earnings are impacted by the variability of
the cash flows of the hedged item. The ineffective portion of all hedges will be
recognized in current period earnings. The adoption of this pronouncement is not
expected to have a material effect on the Company's financial statements.
3. INITIAL PUBLIC OFFERING
On June 24, 1998, the Company consummated its Initial Public Offering
("IPO") of 2,917,000 shares of its Common Stock at a price of $10.00 per share,
2,500,000 of which were issued and sold by the Company and 417,000 of which were
sold by Cognizant Corporation ("Cognizant"), the Company's then majority owner
and controlling parent company. The net proceeds to the Company from the IPO
were approximately $22.4 million after $845 of direct expenses. In July 1998,
IMS Health (the accounting successor to Cognizant) sold 437,550 shares of Class
B Common Stock, which were converted to Class A Common Stock pursuant to an over
allotment option granted to the underwriters of the IPO. Of the total net
proceeds received by the Company upon the consummation of its IPO, approximately
$6.6 million was used to repay the related party balance then owed to Cognizant.
The related party balance resulted from certain advances to the Company from
Cognizant used to purchase the minority interest of the Company's Indian
subsidiary and to fund payroll and accounts payable. Concurrent with the IPO,
the Company reclassified the amounts in mandatorily redeemable common stock to
stockholders' equity as the redemption feature was voided. (See Note 8. to the
Consolidated Financial Statements.)
F-11
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except share and per share data)
4. SUPPLEMENTAL FINANCIAL DATA
Property and Equipment
Property and equipment consist of the following:
Estimated
Useful Life December 31
-----------
(Years) 1998 1997
------- ---- ----
Computer equipment and
purchased software............ 3 $ 5,542 $ 4,196
Furniture and equipment....... 5 - 9 3,044 1,700
Leasehold improvements........ Various 1,805 1,099
------- -------
Sub-total $10,391 $ 6,995
Accumulated depreciation
and amortization............. (4,121) (2,542)
------- -------
Property and Equipment - Net.. $ 6,270 $ 4,453
======= =======
Accrued Expenses and Other Liabilities
Accrued expenses and other current liabilities consist of the following:
December 31,
------------
1998 1997
---- ----
Accrued bonuses and commissions............ $ 6,600 $ 2,003
Accrued vacation........................... 800 415
Other...................................... 3,807 1,241
------- -------
$11,207 $ 3,659
======= =======
5. ACQUISITION OF MINORITY INTEREST
On July 3, 1997, the Company signed a memorandum of understanding to
purchase the 24.0% minority interest in CTS India from a third party. On October
31, 1997, the Company paid $3,468 to the minority shareholder increasing the
Company's ownership in CTS India from 76.0% to 100.0%. The Company accounted for
the acquisition of the minority interest using the purchase method. The
incremental assets acquired have been recorded at their fair value at the date
of acquisition. The excess of purchase price over the fair value of the
incremental net assets acquired has been recorded as goodwill and is being
amortized on a straight-line basis over a seven year
F-12
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except share and per share data)
period. The following is a summary of the purchase price allocation for the
acquisition of the minority interest:
Fair value of assets........................................ $1,727
Deferred taxes.............................................. (482)
Goodwill.................................................... 2,223
-------
Total purchase price........................................ $3,468
======
The results of operations of CTS India have been included in the Company's
operations since the acquisition date. Had the acquisition of the minority
interest taken place on January 1, 1996 or 1997, the results of operations would
not have reflected minority interest expense in each year and would have
reflected amortization of the related goodwill of $317 for 1996 and 1997.
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 matching contribution was $55 and $15 for the year ended
December 31, 1998 and 1997, respectively.
Certain of the Company's employees participate in IMS Health's defined
benefit pension plan. 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 ten percent of their base compensation, which
is matched by an equal contribution by CTS India. Contribution expense
recognized was $186, $128 and $73 for the years ended December 31, 1998 1997 and
1996 respectively.
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 employee salary and
projected turnover rates. Expense recognized by the Company was $135, $94 and
$60 for the years ended December 31, 1998, 1997 and 1996, respectively.
F-13
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except share and per share data)
7. INCOME TAXES
Income (loss) before provision for income taxes consisted of the following
for years ended December 31:
1998 1997 1996
---- ---- ----
U.S............................................ $(2,862) $(1,812) $ (611)
Non-U.S........................................ 12,501 3,966 2,086
------- ------- -------
Total.......................................... $ 9,639 $ 2,154 $1,475
======= ======= =======
The provision (benefit) for income taxes consists of the following for the
years ended December 31,
1998 1997 1996
---- ---- ----
U.S. Federal and state:
Current....................................... $ 75 $ (607) $ (177)
Deferred...................................... 3,516 1,178 518
------- ------- -------
Total U.S. Federal and state.................. $ 3,591 $ 571 $ 341
------- ------- -------
Non-U.S.:
Current....................................... $ 20 $ 18 $ --
Deferred...................................... (5) (8) --
------- ------- -------
Total non-U.S................................. 15 10 --
------- ------- -------
Total......................................... $ 3,606 $ 581 $ 341
======= ======= =======
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:
1998 1997 1996
---- ---- ----
Tax expense at statutory rate................... $ 3,277 $ 732 $ 502
State and Local Income Taxes.................... (110) -- --
Goodwill........................................ 108 26 --
Effect of minority interest on foreign earnings. -- (185) (168)
Other........................................... 331 8 7
------- ------- -------
Total Taxes..................................... $ 3,606 $ 581 $ 341
======= ======= =======
F-14
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except share and per share data)
The Company's deferred tax assets (liabilities) are comprised of the
following at December 31:
1998 1997
---- ----
Deferred tax assets:
Net Operating Losses................................ $ 940 $ 8
Net deferred tax assets............................... $ 940 $ 8
Deferred tax liabilities:
Undistributed Indian income......................... (7,043) (2,601)
Total deferred tax liabilities........................ (7,043) (2,601)
Net deferred tax liability............................ $(6,103) $(2,593)
======== ========
At December 31, 1998, the Company had $940 of tax credit carryforwards primarily
related to U.S. Federal net operating losses, which expire if not used before
2018.
CTS India is an export oriented company that is entitled to claim a tax
holiday for a period of five years from April 1996 through March 2001 in respect
to its export profits. Under the Indian Income Tax Act of 1961, all of the
Company's earnings are currently exempt from Indian Income Tax as profits are
attributable to export operations. However, since management intends to
repatriate all earnings from India to the United States, the Company has
provided deferred U.S. income taxes on all undistributed earnings. 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. All applicable
shares and per share amounts in the accompanying financial statements have been
retroactively adjusted to reflect this recapitalization. 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 437,550 shares of Class A Common Stock. As a result, IMS Health,
the majority owner and controlling parent of the Company, converted 437,550
shares of Class B Common stock into Class A Common Stock and subsequently sold
such shares.
F-15
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except share and per share data)
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 $3.85
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
have been 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 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 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 48,750 shares to CTS's Chairman and Chief Executive Officer at an
exercise price of $6.92 per share, an amount less than the fair market value of
the shares on the date of the grant.
A summary of the Company's stock option activity, and related information
is as follows:
December 31,
------------------------------------------------------
1998 1997
------------------------------------------------------
Weighted Weighted
Average Average
Shares Exercise Price Shares Exercise Price
------ -------------- ------ --------------
Outstanding at beginning of year...... 539,825 $ 4.04 -- --
Granted, Employee Option Plan........ 185,950 9.74 520,325 $3.85
Granted, Directors Option Plan....... 36,500 10.00 19,500 9.08
Exercised............................ (37,111) 3.85 -- --
Canceled............................. (40,138) 5.57 -- --
-------- ------- ------- -----
Outstanding - end of year............ 685,026 $ 5.85 539,825 $4.04
-------- ------- ------- -----
Exercisable - end of year............ 112,065 $ 4.69 -- --
F-16
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except share and per share data)
The following summarizes information about the Company's stock options
outstanding and exercisable by price range at December 31, 1998 and 1997,
respectively:
1998
- ----------------------------------------------------------------------------------------
Options Outstanding Options Exercisable
- --------------------------------------------------- ------------------------------------
Range of
Exercise Number Weighted Average Remaining Weighted Average
Prices Outstanding Contractual Life in Years Options Exercise Price
- ------------- ----------- ------------------------- --------- -----------------
$3.85-$3.85 452,826 8.6 years 89,628 $3.85
$6.92-$10.00 205,200 9.4 years 22,437 $8.06
$10.88-$16.13 25,000 9.7 years -- --
$23.75-$23.75 2,000 9.9 years -- --
$3.85-$23.75 685,026 8.8 years 112,065 $4.69
1997
- ----------------------------------------------------------------------------------------
Options Outstanding Options Exercisable
- --------------------------------------------------- ------------------------------------
Range of
Exercise Number Weighted Average Remaining Weighted Average
Prices Outstanding Contractual Life in Years Options Exercise Price
- ------------- ----------- ------------------------- --------- -----------------
$3.85 520,325 8.6 years -- --
$9.08 19,500 9.0 years -- --
---------- ----------
539,825 --
For 1998, $122 of compensation cost was recognized by the Company under APB
25. No compensation cost was recognized by the Company under APB 25 for 1997 or
1996.
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,
1998 1997 1996
---- ---- ----
Net income
As reported............................... $6,033 $1,028 $642
Pro forma................................. $5,671 $778 $608
As reported
Net income per share, basic............... $0.76 $0.16 $0.10
Net income per share, diluted............. $0.73 $0.16 $0.10
Pro forma
Net income per share, basic............... $0.71 $0.12 $0.09
Net income per share, diluted............. $0.69 $0.12 $0.09
F-17
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except share and per share data)
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 1998; risk-free interest rate
of 5.4 %, expected dividend yield of 0.0%, expected volatility of 48.0% and
expected life of 3.6 years. 1997 assumptions: risk-free interest rate of 6.3%,
expected dividend yield of 0.0%, expected volatility of 40.0% and expected life
of 8.7 years. The weighted-average fair value of the Company's options granted
was $4.68 during 1998. The weighted-average fair value of the Company's options
granted was $2.38 during 1997. 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 assumptions
used in 1997 and 1996 for Cognizant stock options were: risk-free interest rate
of 5.9%, expected dividend yield of 0.3%, expected volatility of 25.0% and
expected life of 4.5 years. The weighted average fair value of IMS Health stock
options granted to certain executive officers in 1998 was $7.14. The weighted
average fair value of Cognizant stock options granted to certain executive
officers in 1997 and 1996 was $9.76 and $13.12, respectively.
10. OTHER TRANSACTIONS WITH AFFILIATES
Background. 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. These operating
units principally included A.C.Nielsen, Dun & Bradstreet Information
Services, Dun & Bradstreet Software, Erisco, Inc. ("Erisco"), IMS
International, Inc. ("IMS"), NCH Promotional Services, Inc. ("NCH Promotional
Services"), Nielsen Media Research, Inc. ("Nielsen Media Research"), The
Reuben H. Donnelley Corporation ("RHDonnelley"), Pilot Software, Inc. ("Pilot
Software") and Sales Technologies, Inc. ("Sales Technologies"), and a
majority interest in Gartner Group, Inc. ("Gartner Group"). In November 1996,
the Company, Erisco, IMS, Nielsen Media Research, Pilot Software, Sales
Technologies and certain other entities, plus a majority interest in Gartner
Group, were spun-off from The Dun & Bradstreet Corporation to form Cognizant,
the then majority owner and controlling parent of the Company. At that time,
ACNielsen was separately spun-off from The Dun & Bradstreet Corporation and
Dun & Bradstreet Software was sold to GEAC Software. In 1997, Cognizant sold
Pilot Software to a third party.
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 July 1998, IMS Health sold 437,550 shares of Class B Common Stock
pursuant to an over allotment option granted to the underwriters of the IPO. As
of December 31, 1998, IMS Health owned a majority and controlling interest in
the outstanding Common Stock of the
F-18
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except share and per share data)
Company and held approximately 94.2% of the combined voting power of the
Company's Common Stock. (See also Note 3. to the Consolidated Financial
Statements.)
IMS Health currently provides the Company with certain administrative
services including payroll and payables processing, e-mail, tax planning and
compliance, and permits the Company to participate in IMS Health's insurance and
employee benefit plans. Costs for these services for all periods prior to the
IPO were allocated to the Company based on utilization of certain specific
services. All subsequent services were performed under the CTS IMS Health
intercompany services agreement.
Affiliated Agreements. In 1997, the Company entered into various agreements
with Cognizant which were assigned to IMS Health as part of the 1998 spin-off.
The agreements include an Intercompany Services Agreement for services provided
by IMS Health such as payroll and payables processing, tax, finance, personnel
administration, 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. (See Item 3.)
Revenues. In 1996, the Company recognized related party revenues totaling
$9,257 including revenues from A.C.Nielsen, Dun & Bradstreet Information
Services, Dun & Bradstreet Software and NCH Promotional Services through
November 1, 1996 (the effective date of the spin-off of Cognizant from The Dun &
Bradstreet Corporation) and revenues from Erisco, IMS, Nielsen Media Research
and Pilot Software are included as related party revenues for the full year.
In 1997, the Company recognized related party revenues totaling $10,846
including revenues from Erisco, IMS, Nielsen Media Research, Sales Technologies,
Pilot Software and Gartner Group for the full year.
In 1998, the Company recognized related party revenues totaling $13,575
including revenues from IMS Health, Nielsen Media Research (through June 30,
1998), Sales Technologies and Gartner Group.
Services. The Company, IMS Health and Nielsen Media Research have entered into
Master Services Agreements pursuant to which the Company provides IT services to
such subsidiaries. IMS Health, Cognizant and The Dun & Bradstreet Corporation
provided the Company with certain administrative services, including financial
planning and administration, legal, tax planning and compliance, treasury and
communications, and permitted the Company to participate in Cognizant's
insurance and employee benefit plans. Costs for these services for all periods
prior to the IPO were allocated to the Company based on utilization of certain
specific services. All subsequent services were performed under the CTS IMS
Health intercompany services agreement. Management believes that these
allocations are reasonable. Total costs in connection with these services were
$1,666, $835, and $354 for the years ended December 31, 1998, 1997 and 1996,
respectively.
F-19
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except share and per share data)
The Company financed the acquisition of the minority interest and its
operations through the expansion and contraction of intercompany balances with
Cognizant, which were repaid with proceeds from the IPO. No interest has been
charged on these transactions.
Such transactions in 1998, 1997 and 1996 are as follows:
1998 1997 1996
---- ---- ----
Loans and advances (repayments), net... $(6,637) $2,251 $315
Purchase of minority interest.......... -- 3,418 --
-------- ------- ---------
Proceeds (to) from related party....... $(6,637) $5,669 $315
======== ======= =========
Leases. Beginning January 1, 1997 through December 31, 1998, the Company began
subleasing office space from a subsidiary of IMS Health. The Company made annual
lease payments to the subsidiary of $107 and $99 in 1998 and 1997, respectively.
Pension Plans. Certain 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 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 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 common stock upon the consummation of the
Company's initial public offering. 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. In July 1998, IMS Health
granted an executive officer options to purchase an aggregate of 8,158 shares of
the common stock of IMS Health at an exercise price of $30.17 per share.
In November 1996, Cognizant granted an executive officer options to
purchase an aggregate of 60,000 shares (on a pre-split basis) of the common
stock of Cognizant 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 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. 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.
F-20
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except share and per share data)
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 of the common stock of IMS Health at an exercise price of $30.17 per
share.
11. COMMITMENTS
The Company leases office space under operating leases which expire at
various dates through the year 2007. 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,
1998 are as follows:
1999............................................................ $1,305
2000............................................................ 1,203
2001............................................................ 1,052
2002............................................................ 789
2003............................................................ 546
Thereafter...................................................... 139
-------
Total minimum lease payments.................................... $5,034
=======
Rental expense totaled $1,260, $509 and $241 for years ended December 31,
1998, 1997 and 1996, respectively.
At December 31, 1997, the Company had a letter of credit in the amount of
$725 for the purchase of a mainframe computer. Subsequent to year end, the
letter of credit was paid.
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
F-21
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except share and per share data)
one or more large claims against the Company that exceed available insurance
coverage or changes in the Company's insurance policies, including premium
increases or the imposition of large deductible or co-insurance requirements,
would have a material adverse effect on the Company's business, results of
operations and financial condition.
13. SEGMENT INFORMATION
The Company delivers full life cycle solutions to complex software
development and maintenance problems through the use of a seamless on-site and
offshore consulting project team. These solutions include application
development and maintenance services, Year 2000 and Eurocurrency compliance
services, testing and quality assurance services and re-hosting and
re-engineering services. The Company has adopted SFAS No. 131, "Disclosures
About Segments of an Enterprise and Related Information." Information about the
Company's operations and total assets in North America, Europe and Asia for the
three years ended December 31, 1998, 1997 and 1996 are as follows:
1998 1997 1996
---- ---- ----
REVENUES (1)
North America....................... $47,883 $21,217 $9,641
Europe.............................. 10,481 3,177 2,114
Asia................................ 242 350 277
-------- --------- ----------
Consolidated........................ $58,606 $24,744 $12,032
======== ========= ==========
OPERATING INCOME (1)
North America....................... $6,724 $1,685 $1,128
Europe.............................. 2,098 400 303
Asia................................ 96 44 35
-------- --------- ----------
Consolidated........................ $8,918 $2,129 $1,466
======== ========= ==========
IDENTIFIABLE ASSETS
North America....................... $36,294 $9,930 $3,110
Europe.............................. 2,846 60 --
India............................... 12,539 8,308 4,717
-------- --------- ----------
Consolidated........................ $51,679 $18,298 $7,827
======== ========= ==========
(1) Revenues and resulting operating income are attributed to regions based upon
customer location.
The Company, operating globally, provides software development and
maintenance services for medium and large businesses. North American operations
consist primarily of software development and maintenance consulting services in
the United States and Canada. European operations consist primarily of software
development and maintenance services principally in the United Kingdom and
Germany. Asian operations consist primarily of software development and
maintenance consulting services principally in India.
F-22
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except share and per share data)
In 1998, sales to one related party customer accounted for 23.2% of
revenues and two third party customers accounted for 12.5% and 11.3% of
revenues, respectively. In 1997, sales to one related party customer accounted
for 44.3% of revenues and one third party customer accounted for 13.9% of
revenues. In 1996 one related party customer accounted for 78.0% of revenues.
QUARTERLY FINANCIAL DATA (UNAUDITED)
Three Months Ended
1998 March 31 June 30 September 30 December 31 Full Year
- -----------------------------------------------------------------------------------------------
Operating Revenue $10,238 $12,668 $16,200 $19,500 $58,606
Operating Income $1,124 $1,582 $2,435 $3,777 $8,918
Net Income $712 $1,066 $1,700 $2,555 $6,033
Earnings Per Share of Common Stock
Basic $0.11 $0.15 $0.19 $0.28 $0.76
Diluted $0.10 $0.15 $0.18 $0.27 $0.73
- -----------------------------------------------------------------------------------------------
Three Months Ended
1997 March 31 June 30 September 30 December 31 Full Year
- -----------------------------------------------------------------------------------------------
Operating Revenue $4,257 $5,319 $7,146 $8,022 $24,744
Operating Income $165 $330 $593 $1,041 $2,129
Net Income $43 $107 $215 $663 $1,028
Earnings Per Share of Common Stock
Basic $0.01 $0.02 $0.03 $0.10 $0.16
Diluted $0.01 $0.02 $0.03 $0.10 $0.16
- -----------------------------------------------------------------------------------------------
F-23
COGNIZANT TECHNOLOGY SOLUTIONS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(in thousands, except share and per share data)
Cognizant Technology Solutions Corporation
Valuation and Qualifying Accounts
(Dollars in Thousands)
Accounts Receivable Allowance:
Balance at Charged to Charged to Balance at
Beginning of Costs and Other Accounts End of Period
Year Period Expenses Deductions
1998 $ 239 $ 45 $ 10 $ 274
1997 -- 239 -- 239
1996 -- -- -- --
F-24