News Column

COGNIZANT TECHNOLOGY SOLUTIONS CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.

May 8, 2014

Executive Summary

We are a leading provider of information technology (IT), consulting and business process services, dedicated to helping the world's leading companies build stronger businesses. Our clients engage us to help them build more efficient operations, provide solutions to critical business and technology problems, and to help them drive technology-based innovation and growth. Our core competencies include: Business, Process, Operations and IT Consulting, Application Development and Systems Integration, Enterprise Information Management, or EIM, Application Testing, Application Maintenance, IT Infrastructure services, or IT IS, and Business Process Services, or BPS. We tailor our services to specific industries and utilize an integrated global delivery model. This seamless global sourcing model combines client service teams based on-site at the client locations with delivery teams located at dedicated near-shore and offshore global delivery centers. For the three months ended March 31, 2014, our revenue increased to $2,422.3 million compared to $2,020.7 million for the three months ended March 31, 2013. Net income increased to $348.9 million or $0.57 per diluted share, compared to net income of $284.2 million or $0.47 per diluted share. On a non-GAAP basis our diluted earnings per share increased to $0.621 compared to $0.511 for the three months ended March 31, 2013.



The key drivers of our revenue growth during the three months ended March 31, 2014 were as follows:

Strong performance across all of our business segments with revenue growth

ranging from 18.0% to 20.8%;



Continued penetration of the European and Rest of World (primarily the

Asia Pacific) markets where we experienced revenue growth of 35.0% and

28.4%, respectively, as compared to the quarter ended March 31, 2013. Our

European revenue growth benefited from our acquisitions of six C1 group companies and Equinox in 2013;



Sustained strength in the North American market where revenues grew 16.1%,

as compared to the quarter ended March 31, 2013; Increased customer spending on discretionary projects;



Expansion of our service offerings, including Consulting, IT IS, and BPS

services, which enabled us to cross-sell new services to our customers and

meet the rapidly growing demand for complex large-scale outsourcing

solutions; Increased penetration at existing customers, including strategic clients;

and



Continued expansion of the market for global delivery of IT services and

BPS.

We saw a continued demand from our customers for a broad range of services, including IT strategy and business consulting, application development and systems integration, EIM, application testing, application maintenance, IT IS, and BPS. In addition, we are seeing an increased customer interest in our social, mobile, analytics and cloud-based services. We finished the first quarter with approximately 1,223 active clients, compared to approximately 1,000 active clients as of March 31, 2013, and increased the number of strategic clients by 7 during the quarter, bringing the total number of our strategic clients to 250. We define a strategic client as one offering the potential to generate at least $5 million to $50 million or more in annual revenues at maturity. Our revenue growth is also attributed to increasing market acceptance of, and strong demand for, offshore IT software and services and BPS. NASSCOM (India'sNational Association of Software and Service Companies) reports indicate that export revenues from India's IT software and services and BPS sectors are expected to grow approximately 13% to 15% for NASSCOM's fiscal year ending March 31, 2015. For the fiscal year ended 2014, the industry recorded export revenue growth of 13%, the mid-point of NASSCOM's growth projection. 1 Non-GAAP diluted earnings per share is not a measurement of financial performance prepared in accordance with GAAP. See "Non-GAAP Financial



Measures" for more information and a reconciliation to the most directly

comparable GAAP financial measure. 17



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Our operating margin increased to approximately 19.0% for the quarter ended March 31, 2014 compared to 18.1% for the quarter ended March 31, 2013. Our non-GAAP operating margin for the quarter ended March 31, 2014 was approximately 20.8%2 compared to 19.9%2 for the quarter ended March 31, 2013. The increase in our GAAP and non-GAAP operating margins was due to revenue growth outpacing headcount growth and the impact of the depreciation of the Indian rupee against the U.S. dollar, net of losses on our cash flow hedges, partially offset by increases in compensation and benefit costs, including incentive-based compensation. Historically, we have invested our profitability above the 19% to 20% non-GAAP operating margin level back into our business, which we believe is a significant contributing factor to our strong revenue growth. This investment is primarily focused in the areas of hiring client partners and relationship personnel with specific industry experience or domain expertise, training our technical staff in a broader range of service offerings, strengthening our business analytics capabilities, strengthening and expanding our portfolio of services, continuing to expand our geographic presence for both sales and delivery as well as recognizing and rewarding exceptional performance by our employees. In addition, this investment includes maintaining a level of resources, trained in a broad range of service offerings, to be well positioned to respond to our customer requests to take on additional projects. We expect to continue to invest amounts in excess of our targeted operating margin levels back into the business. We finished the first quarter of 2014 with approximately 178,600 employees, which is an increase of approximately 15,900 as compared to March 31, 2013. The increase in the number of our technical personnel and the related infrastructure costs to meet the demand for our services is the primary driver of the increase in our operating expenses in 2014. Annualized turnover, including both voluntary and involuntary, was approximately 14.1% for the three months ended March 31, 2014. The majority of our turnover occurs in India. As a result, annualized attrition rates on-site at clients are below our global attrition rate. In addition, attrition is weighted towards the more junior members of our staff. We have experienced increases in compensation and benefit costs, including incentive-based compensation costs, in India which may continue in the future; however, historically, this has not had a material impact on our results of operations as we have been able to absorb such cost increases through price increases or cost management strategies such as managing discretionary costs, the mix of our professional staff as well as utilization levels, and achieving other operating efficiencies. At March 31, 2014, we had cash, cash equivalents and short-term investments of $3,865.0 million and working capital of $4,787.9 million. Accordingly, we do not anticipate any near-term liquidity issues.



During the remainder of 2014, barring any unforeseen events, we expect the following factors to affect our business and our operating results:

Continued focus by customers on directing IT spending towards cost containment projects, such as application maintenance, IT IS and BPS;



Demand from our customers to help them achieve their dual mandate of

simultaneously achieving cost savings while investing in innovation;

Secular changes driven by evolving technologies and regulatory changes;

Volatility in foreign currency rates; and Continued uncertainty in the world economy.



In response to this macroeconomic environment, we plan to:

Continue to invest in our talent base and new service offerings;



Partner with our existing customers to garner an increased portion of our

customers' overall IT spend by providing innovative solutions; Continue our focus on growing our business in Europe, the Middle East, the

Asia Pacific and Latin America regions, where we believe there are opportunities to gain market share; Continue to increase our strategic customer base across all of our business segments;



Opportunistically look for acquisitions that may improve our overall

service delivery capabilities, expand our geographic presence and/or

enable us to enter new areas of technology;



Continue to focus on operating discipline in order to appropriately manage

our cost structure; and Continue to locate most of our new development center facilities in tax

incentivized areas.



2 Non-GAAP operating margin is not a measurement of financial performance

prepared in accordance with GAAP. See "Non-GAAP Financial Measures" for more

information and a reconciliation to the most directly comparable GAAP financial measure. 18



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Stock Split

On February 4, 2014, the company's Board of Directors declared a two-for-one stock split of our Class A common stock in the form of a 100% stock dividend, which was paid on March 7, 2014 to stockholders of record as of February 21, 2014. The stock split has been reflected in the accompanying condensed consolidated financial statements, and all applicable references as to the number of outstanding common shares and per share information herein, except par values, have been retroactively adjusted to reflect the stock split as if it occurred at the beginning of the earliest period presented.



Business Segments

Our four reportable business segments are:

Financial Services, which includes customers providing banking/transaction

processing, capital markets and insurance services;



Healthcare, which includes healthcare providers and payers as well as life

sciences customers; Manufacturing/Retail/Logistics, which includes consumer goods



manufacturers, retailers, travel and other hospitality customers, as well

as customers providing logistics services; and Other, which is an aggregation of industry operating segments each of



which, individually, represents less than 10.0% of consolidated revenues

and segment operating profit. The Other reportable segment includes our

information, media and entertainment services, communications, and high technology operating segments. Our chief operating decision maker evaluates Cognizant's performance and allocates resources based on segment revenues and operating profit. Segment operating profit is defined as income from operations before unallocated costs. Generally, operating expenses for each operating segment have similar characteristics and are subject to the same factors, pressures and challenges. However, the economic environment and its effects on industries served by our operating segments may affect revenue and operating expenses to differing degrees. Expenses included in segment operating profit consist principally of direct selling and delivery costs as well as a per seat charge for use of the development and delivery centers. Certain selling, general and administrative expenses, excess or shortfall of incentive compensation for delivery personnel as compared to target, stock-based compensation expense, a portion of depreciation and amortization and the impact of the settlements of our cash flow hedges are not allocated to individual segments in internal management reports used by the chief operating decision maker. Accordingly, such expenses are excluded from segment operating profit. We had approximately 1,223 active clients as of March 31, 2014. Accordingly, we provide a significant volume of services to many customers in each of our business segments. Therefore, a loss of a significant customer or a few significant customers in a particular segment could materially reduce revenues for that segment. However, no individual customer accounted for sales in excess of 10% of our consolidated revenues for the periods ended March 31, 2014 and 2013. In addition, the services we provide to our larger customers are often critical to the operations of such customers and we believe that a termination of our services would require an extended transition period with gradually declining revenues. 19



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Results of Operations

Three Months Ended March 31, 2014 Compared to Three Months Ended March 31, 2013

The following table sets forth, for the periods indicated, certain financial data for the three months ended March 31:

(Dollars in thousands, except per share amounts)

Increase % of % of (Decrease) 2014 Revenues 2013 Revenues $ % Revenues $ 2,422,348 100.0 $ 2,020,738 100.0 $ 401,610 19.9 % Cost of revenues(1) 1,432,444 59.1 1,199,965 59.4 232,479 19.4 % Selling, general and administrative expenses(1) 485,395 20.0 413,204 20.4 72,191 17.5 % Depreciation and amortization expense 44,473 1.8 41,662 2.1 2,811 6.7 % Income from operations 460,036 19.0 365,907 18.1 94,129 25.7 % Other income (expense), net 13,152 11,276 1,876 16.6 % Income before provision for income taxes 473,188 19.5 377,183 18.7 96,005 25.5 % Provision for income taxes 124,310 92,974 31,336 33.7 % Net income $ 348,878 14.4 $ 284,209 14.1 $ 64,669 22.8 % Diluted earnings per share $ 0.57$ 0.47$ 0.10 Other Financial Information (2) Non-GAAP income from operations and non-GAAP operating margin $ 503,793 20.8 $ 401,654 19.9 $ 102,139 25.4 % Non-GAAP diluted earnings per share $ 0.62$ 0.51$ 0.11



(1) Exclusive of depreciation and amortization expense.

(2) Non-GAAP income from operations, non-GAAP operating margin and non-GAAP

diluted earnings per share are not measurements of financial performance

prepared in accordance with GAAP. See "Non-GAAP Financial Measures" for more

information and a reconciliation to the most directly comparable GAAP

financial measure.

Revenue - Overall. Revenue increased 19.9%, or approximately $401.6 million, from approximately $2,020.7 million during the three months ended March 31, 2013 to approximately $2,422.3 million during the three months ended March 31, 2014. This increase was primarily attributed to greater acceptance of our global delivery model among an increasing number of industries, continued interest in using our global delivery model as a means to reduce overall IT and operations costs, increased customer spending on discretionary projects, and continued penetration in all our geographic markets. Revenues from new customers contributed $91.4 million representing 22.8% of the period over period revenue growth. Our consulting and technology services revenues increased by approximately 23.7% compared to the three months ended March 31, 2013 and represented approximately 51.3% of total revenues for the three months ended March 31, 2014, while our outsourcing services revenue increased by approximately 16.1% and constituted approximately 48.7% of total revenues, for the three months ended March 31, 2014. We had approximately 1,223 active clients as of March, 31, 2014 as compared to approximately 1,000 active clients as of March 31, 2013. Revenues from our top five customers as a percentage of total revenues were 13.1% and 14.1% for the quarter ended March 31, 2014 and 2013, respectively. Revenues from our top ten customers as a percentage of total revenues were 22.4%, and 24.4% for the quarter ended March 31, 2014 and 2013, respectively. As we continue to add new customers and increase our penetration at existing customers, we expect the percentage of revenues from our top five and top ten customers to decline over time. 20



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Revenue - Reportable Segments. Revenues by reportable business segment were as follows for the three months ended March 31:

(Dollars in thousands) Increase 2014 2013 $ % Financial services $ 1,023,704$ 855,341$ 168,363 19.7 Healthcare 615,916 510,019 105,897 20.8 Manufacturing/Retail/Logistics 511,931 425,846 86,085 20.2 Other 270,797 229,532 41,265 18.0 Total revenue $ 2,422,348$ 2,020,738$ 401,610 19.9 Revenue from our Financial Services segment grew 19.7% or $168.4 million for the three months ended March 31, 2014, as compared to the three months ended March 31, 2013. This strength was driven by revenue growth of $115.8 million from our banking customers who continued to benefit from the improving economy. In this segment, revenue from customers added since March 31, 2013 was approximately $27.0 million and represented 16.0% of the period-over-period revenue increase in this segment. Key areas of focus for our Financial Services customers included cost optimization, regulatory and compliance driven initiatives, risk management, and the adoption and integration of SMAC solutions to align with shifts in consumer preferences. Revenue from our Healthcare segment grew 20.8% or $105.9 million for the three months ended March 31, 2014, as compared to the three months ended March 31, 2013. Our healthcare and life sciences customers contributed approximately $94.4 million and $11.5 million, respectively, to the period-over-period revenue increase. Revenue from customers added since March 31, 2013 was approximately $26.2 million and represented 24.7% of the period-over-period revenue increase in this segment. Growth within the segment was driven by work related to Affordable Care Act initiatives in the United States, including extended support for member enrollment and the implementation of direct to consumer programs through mobile platforms. IT spending by some of our life sciences customers has been and may continue to be adversely impacted by the patent cliff affecting some of our pharmaceutical customers. Revenue from our Manufacturing/Retail/Logistics segment grew 20.2% or $86.1 million for the three months ended March 31, 2014, as compared to the three months ended March 31, 2013. During the first quarter of 2014, growth was stronger among our manufacturing and logistics customers, where revenue increased by approximately $50.6 million as compared to approximately $35.5 million for our retail and hospitality customers. Revenue from customers added since March 31, 2013 was approximately $25.8 million and represented approximately 30.0% of the period-over-period revenue increase in this segment. Demand within this segment continues to be driven by multichannel commerce implementation and integration efforts, supply chain consulting and implementation initiatives, and increased adoption of SMAC solutions to align with shifts in consumer preferences. Revenue from our Other segment grew 18.0% or $41.3 million for the three months ended March 31, 2014, as compared to the three months ended March 31, 2013. In the first quarter of 2014, growth within Other was particularly strong among our high technology customers, where revenue increased by approximately $24.8 million due to an increase in discretionary spending, and telecommunication customers, where revenues increased by approximately $15.6 million. Revenue from customers added since March 31, 2013 was approximately $12.5 million and represented 30.3% of the period-over-period revenue increase in this segment.



Revenue - Geographic Locations. Revenues by geographic location were as follows for the three months ended March 31:

(Dollars in thousands) Increase 2014 2013 $ % North America $ 1,836,231$ 1,582,191$ 254,040 16.1 United Kingdom 277,526 216,408 61,118 28.2 Rest of Europe 192,619 131,848 60,771 46.1 Europe - Total 470,145 348,256 121,889 35.0 Rest of World 115,972 90,291 25,681 28.4 Total Revenue $ 2,422,348$ 2,020,738$ 401,610 19.9 21



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North America continues to be our largest market representing approximately 75.8% of total revenue for the first quarter of 2014 and accounted for $254.0 million of the $401.6 million revenue increase from first quarter of 2013. Revenue from Europe grew 35.0% compared to 2013. The strong revenue growth in Europe was driven by the increasing acceptance of our global delivery model and Europe's continued economic recovery. We believe the European market is under-penetrated and represents a significant future growth opportunity for us. Revenue growth in Rest of Europe includes the benefit of recent acquisitions of six C1 group companies and Equinox. Revenue growth from Rest of World customers in 2014 was primarily driven by the India, Middle East, and Singapore markets. We believe that Europe, the Middle East, the Asia Pacific and Latin America regions will continue to be areas of significant investment for us as we see these regions as growth opportunities for the long term. Cost of Revenues (Exclusive of Depreciation and Amortization Expense). Our cost of revenues consists primarily of salaries, incentive-based compensation, stock-based compensation expense, payroll taxes, employee benefits, immigration and project-related travel for technical personnel, subcontracting and sales commissions related to revenues. Our cost of revenues increased by 19.4% or $232.5 million during the first quarter of 2014 as compared to the first quarter of 2013. The increase was due primarily to an increase in compensation and benefits costs, including incentive-based compensation, partially offset by the favorable impact of the depreciation of the Indian rupee versus the U.S. dollar. For the three months ended March 31, 2014, compensation and benefit costs, including incentive-based compensation, increased by approximately $200.2 million as a result of the increase in the number of our technical personnel and higher accrual of individual bonus payouts. Selling, General and Administrative Expenses. Selling, general and administrative expenses consist primarily of salaries, incentive-based compensation, stock-based compensation expense, payroll taxes, employee benefits, immigration, travel, marketing, communications, management, finance, administrative and occupancy costs. Selling, general and administrative expenses, including depreciation and amortization, increased by 16.5%, or $75.0 million during the first quarter of 2014 as compared to the first quarter of 2013. Selling, general and administrative expenses, including depreciation and amortization, decreased as a percentage of revenue to 21.9% in the first quarter of 2014 as compared to 22.5% in the first quarter of 2013. The decrease as a percentage of revenue was due primarily to economies of scale that allowed us to leverage our cost structure over a larger organization and the favorable impact of the depreciation of the Indian rupee versus the U.S. dollar, net of losses on our cash flow hedges. Income from Operations and Operating Margin - Overall. Income from operations increased 25.7%, or approximately $94.1 million in the first quarter of 2014 as compared to the first quarter of 2013. Our operating margin increased to 19.0% of revenues in the first quarter 2014 from 18.1% of revenues in the first quarter of 2013, due to revenue growth outpacing headcount growth and the impact of the depreciation of the Indian rupee against the U.S. dollar, net of losses on our cash flow hedges, partially offset by increases in compensation and benefit costs, including incentive-based compensation costs. Excluding the impact of applicable designated cash flow hedges, the depreciation of the Indian rupee against the U.S. dollar positively impacted our operating margin by approximately 264 basis points or 2.64 percentage points in the three months ended March 31, 2014. Each additional 1.0% change in exchange rate between the Indian rupee and the U.S. dollar will have the effect of moving our operating margin by approximately 19 basis points or 0.19 percentage points. For the three months ended March 31, 2014 and 2013, our non-GAAP operating margins were 20.8%3, and 19.9%3, respectively. As set forth in the "Non-GAAP Financial Measures" section below, our non-GAAP operating margin excludes stock based compensation expense and acquisition-related charges. We entered into foreign exchange forward contracts to hedge certain Indian rupee denominated payments in India. These hedges are intended to mitigate the volatility of the changes in the exchange rate between the U.S. dollar and the Indian rupee. During the three months ended March 31, 2014 and 2013, the settlement of certain cash flow hedges negatively impacted our operating margin by approximately 167 basis points or 1.67 percentage points and 106 basis points or 1.06 percentage points, respectively.



3 Non-GAAP operating margin is not a measurement of financial performance

prepared in accordance with GAAP. See "Non-GAAP Financial Measures" for more

information and a reconciliation to the most directly comparable GAAP financial measure. 22



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Segment Operating Profit. Segment operating profits were as follows:

(Dollars in thousands) Increase 2014 2013 $ % Financial Services $ 347,929$ 265,234$ 82,695 31.2 Healthcare 214,269 177,074 37,195 21.0



Manufacturing/Retail/Logistics 181,681 131,026 50,655 38.7

Other 89,667 71,060



18,607 26.2

Total segment operating profit 833,546 644,394 189,152 29.4

Less: unallocated costs(1) 373,510 278,487 95,023 34.1 Income from operations $ 460,036$ 365,907$ 94,129 25.7



(1) Includes $35,817 and $29,093 of stock-based compensation expense for the

three months ended March 31, 2014 and 2013, respectively.

The increase in segment operating profit in all reportable segments during the first quarter of 2014 was attributable primarily to increased revenues, the favorable impact of the depreciation of the Indian rupee versus the U.S. dollar and achieving operating efficiencies, partially offset by an increase in compensation and benefit costs resulting primarily from additional headcount to support our revenue growth and continued investment in sales and marketing. Other Income (Expense), Net. Total other income (expense), net consists primarily of foreign currency exchange gains and (losses) and interest income. The following table sets forth total other income (expense), net for the three months ended March 31: (Dollars in thousands) Increase 2014 2013 (Decrease) Foreign currency exchange gains (losses) $ 7,133 $



(1,425 ) $ 8,558 (Losses) on foreign exchange forward contracts not designated as hedging instruments

(8,350 )



(2,326 ) (6,024 )

Net foreign currency exchange (losses) (1,217 ) (3,751 ) 2,534 Interest income 13,505 13,247 258 Other, net 864 1,780 (916 ) Total other income (expense), net $ 13,152 $



11,276 $ 1,876

The foreign currency exchange gains of approximately $7.1 million were primarily attributed to the remeasurement of the Indian rupee denominated net monetary assets on the books of our India subsidiaries to the U.S. dollar functional currency. The $8.4 million of losses on foreign exchange forward contracts not designated as hedging instruments relate to the realized and unrealized gains on foreign exchange forward contracts entered into primarily to offset foreign currency exposure to Indian rupee denominated net monetary assets. As of March 31, 2014, the notional value of our undesignated hedges was $241.3 million. The increase in interest income of $0.3 million was primarily attributed to the increases in the yield on our investments, and an increase in average invested balances, partially offset by the depreciation of the Indian rupee against the U.S. dollar. Provision for Income Taxes. The provision for income taxes increased to approximately $124.3 million during the three months ended March 31, 2014 from to approximately $93.0 million during the three months ended March 31, 2013. The effective income tax rate increased to 26.3% for the three months ended March 31, 2014 from 24.6% for the three months ended March 31, 2013. The increase in our effective income tax rate was primarily attributed to changes in the geographic mix of our current year earnings towards countries with higher statutory rates and a scheduled reduction of certain income tax holiday benefits in India in 2014.



Net Income. Net income increased to approximately $348.9 million for the three months ended March 31, 2014 from approximately $284.2 million for the three months ended March 31, 2013, representing 14.4% and 14.1% of revenues, respectively.

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Non-GAAP Financial Measures

Portions of our disclosure, including the following table, include non-GAAP income from operations, non-GAAP operating margin, and non-GAAP diluted earnings per share. These non-GAAP financial measures are not based on any comprehensive set of accounting rules or principles and should not be considered a substitute for, or superior to, financial measures calculated in accordance with GAAP, and may be different from non-GAAP measures used by other companies. In addition, these non-GAAP measures should be read in conjunction with our financial statements prepared in accordance with GAAP. The reconciliations of Cognizant's non-GAAP financial measures to the corresponding GAAP measures should be carefully evaluated. Our non-GAAP income from operations and non-GAAP operating margin exclude stock-based compensation expense and acquisition-related charges. In 2014, we modified our definition of non-GAAP diluted EPS to exclude net non-operating foreign currency exchange gains or losses, in addition to excluding stock-based compensation expense and acquisition-related charges. Our definition of non-GAAP income from operations and non-GAAP operating margin remains unchanged. We seek to manage the company to a targeted non-GAAP operating margin of 19% to 20% of revenues. We believe providing investors with an operating view consistent with how we manage the company provides enhanced transparency into the operating results of the company. For our internal management reporting and budgeting purposes, we use non-GAAP financial information that does not include stock-based compensation expense, acquisition-related charges and net non-operating foreign currency exchange gains or losses for financial and operational decision making, to evaluate period-to-period comparisons and for making comparisons of our operating results to those of our competitors. Therefore, it is our belief that the use of non-GAAP financial measures excluding these costs provides a meaningful measure for investors to evaluate our financial performance. Accordingly, we believe that the presentation of non-GAAP income from operations, non-GAAP operating margin and non-GAAP diluted earnings per share, when read in conjunction with our reported GAAP results, can provide useful supplemental information to our management and investors regarding financial and business trends relating to our financial condition and results of operations. A limitation of using non-GAAP financial measures versus financial measures calculated in accordance with GAAP is that non-GAAP measures do not reflect all of the amounts associated with our operating results as determined in accordance with GAAP and exclude costs that are recurring, namely stock-based compensation expense, certain acquisition-related charges, and net non-operating foreign currency exchange gains or losses. In addition, other companies may calculate non-GAAP financial measures differently than us, thereby limiting the usefulness of these non-GAAP financial measures as a comparative tool. We compensate for this limitation by providing specific information regarding the GAAP amounts excluded from non-GAAP income from operations, non-GAAP operating margin and non-GAAP diluted earnings per share to allow investors to evaluate such non-GAAP financial measures with financial measures calculated in accordance with GAAP. 24



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The following table presents a reconciliation of each non-GAAP financial measure to the most comparable GAAP measure for the three months ended March 31:

(Dollars in thousands, except per share amounts)

% of % of 2014 Revenues 2013 Revenues GAAP income from operations and operating margin $ 460,036 19.0 $ 365,907 18.1 Add: Stock-based compensation expense 35,817 1.5 29,093 1.4 Add: Acquisition-related charges (1) 7,940 0.3 6,654 0.3 Non-GAAP income from operations and non-GAAP operating margin $ 503,793 20.8 $ 401,654 19.9 GAAP diluted earnings per share $ 0.57$ 0.47 Effect of above operating adjustments, net of tax 0.05



0.04

Effect on non-operating foreign currency exchange gains and losses, net of tax (2) -



-

Non-GAAP diluted earnings per share $ 0.62$ 0.51



(1) Acquisition-related charges include, when applicable, amortization of

purchased intangible assets included in the depreciation and amortization

expense line on our condensed consolidated statements of operations, external

deal costs, acquisition-related retention bonuses, integration costs, changes

in the fair value of contingent consideration liabilities, charges for

impairment of acquired intangible assets and other acquisition-related costs.

(2) Non-operating foreign currency exchange gains and losses are inclusive of

gains and losses on related foreign exchange forward contracts not designated

as hedging instruments for accounting purposes. Per share impact for the

periods presented rounds to zero.

Liquidity and Capital Resources

At March 31, 2014, we had cash, cash equivalents and short-term investments of $3,865.0 million. We have used, and plan to use, such cash for expansion of existing operations, including our offshore development and delivery centers, continued development of new service lines, acquisitions of related businesses, formation of joint ventures, stock repurchases and general corporate purposes, including working capital. As of March 31, 2014, we had no third party debt and had working capital of approximately $4,787.9 million. Accordingly, we do not anticipate any near-term liquidity issues.



The following table provides a summary of the major cash flows and liquidity trends for the three months ended March 31:

(Dollars in thousands) Increase / 2014 2013 Decrease Net cash from operating activities $ 157,320$ 73,468$ 83,852 Net cash (used in) investing activities (433,654 )



(185,874 ) (247,780 ) Net cash (used in) provided by financing activities (6,573 ) 16,932

(23,505 ) Operating activities. The increase was primarily attributed to an increase in net income during the 2014 period. Trade accounts receivable increased to approximately $1,703.6 million at March 31, 2014 from approximately $1,648.8 million at December 31, 2013. Unbilled accounts receivable increased to approximately $267.3 million at March 31, 2014 from approximately $226.5 million at December 31, 2013. The increase in trade accounts receivable and unbilled receivables as of March 31, 2014 as compared to December 31, 2013 was primarily due to increased revenues. We monitor turnover, aging and the collection of accounts receivable through the use of management reports that are prepared on a customer basis and evaluated by our finance staff. At March 31, 2014, our days sales outstanding, including unbilled receivables, was approximately 73 days as compared to 73 days at December 31, 2013 and 76 days as of March 31, 2013. Investing activities. The increase in net cash used in investing activities is primarily related to additional investments in available-for-sale securities, partially offset by lower expenditures on business combinations and property and equipment during the 2014 period. 25



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Financing activities. Cash from financing activities decreased in the 2014 period primarily due to greater repurchases of common stock under our stock repurchase program.

We expect our operating cash flow and cash and cash equivalents to be sufficient to meet our operating requirements for the next twelve months. Our ability to expand and grow our business in accordance with current plans, to make acquisitions and form joint ventures and to meet our long-term capital requirements beyond a twelve month period will depend on many factors, including the rate, if any, at which our cash flow increases, our ability and willingness to enter into acquisitions and joint ventures with capital stock, our continued intent not to repatriate foreign earnings, and the availability, pricing and terms of public and private debt and equity financings. As of March 31, 2014, $2,194.5 million of our cash, cash equivalents and short-term investments was held by our foreign subsidiaries. We utilize certain strategies in an effort to ensure that our worldwide cash is available in the locations in which it is needed. Most of the amounts held outside of the United States could be repatriated to the United States but, under current law, would be subject to income taxes in the United States, less applicable foreign tax credits. Other than amounts for which we have already accrued U.S. taxes, we intend to indefinitely reinvest these funds outside the United States and our current plans do not indicate a need to repatriate these amounts to fund our cash needs in the United States. If such earnings are repatriated in the future, or are no longer deemed to be indefinitely reinvested, we will accrue the applicable amount of taxes associated with such earnings at that time. Due to the various methods by which such earnings could be repatriated in the future, it is not practicable to determine the amount of tax that would result from such repatriation. Commitments and Contingencies As of March 31, 2014, we had outstanding fixed capital commitments of approximately $47.7 million related to our India development center expansion program, which includes expenditures for land acquisition, facilities construction and furnishings to build new state-of-the-art development and delivery centers in regions primarily designated as Special Economic Zones, or SEZs located in India. We are involved in various claims and legal actions arising in the ordinary course of business. We accrue a liability when a loss is considered probable and the amount can be reasonably estimated. In the opinion of management, the outcome of any existing claims and legal or regulatory proceedings, if decided adversely, is not expected to have a material adverse effect on our business, financial condition, results of operations and cash flows. Additionally, many of our engagements involve projects that are critical to the operations of our customers' business and provide benefits that are difficult to quantify. Any failure in a customer's systems or our failure to meet our contractual obligations to our clients, including any breach involving a customer's confidential information or sensitive data, or our obligations under applicable laws or regulations could result in a claim for substantial damages against us, regardless of our responsibility for such failure. Although we attempt to contractually limit our liability for damages arising from negligent acts, errors, mistakes, or omissions in rendering our services, there can be no assurance that the limitations of liability set forth in our contracts will be enforceable in all instances or will otherwise protect us from liability for damages. Although we have general liability insurance coverage, including coverage for errors or omissions, there can be no assurance that such coverage will cover all types of claims, continue to be available on reasonable terms or will be available in sufficient amounts to cover one or more large claims, or that the insurer will not disclaim coverage as to any future claim. The successful assertion of one or more large claims against us that exceed or are not covered by our insurance coverage or changes in our insurance policies, including premium increases or the imposition of large deductible or co-insurance requirements, could have a material adverse effect on our business, results of operations, financial condition and cash flows.



Foreign Currency Risk

Overall, we believe that we have limited revenue risk resulting from movement in foreign currency exchange rates as approximately 75.8% of our revenues for the three months ended March 31, 2014 were generated from customers located in North America. However, a portion of our costs in India, representing approximately 23.8% of our global operating costs for the three months ended March 31, 2014, are denominated in the Indian rupee and are subject to foreign exchange rate fluctuations. These foreign currency exchange rate fluctuations have an impact on our results of operations. In addition, a portion of our balance sheet is exposed to foreign currency exchange rate fluctuations, which may result in non-operating foreign currency exchange gains or losses upon remeasurement. For the three months ended March 31, 2014, we reported foreign currency exchange gains, exclusive of hedging gains or losses, of approximately $7.1 million, which were primarily attributed to the remeasurement of the Indian rupee denominated net monetary assets on the books of our India subsidiaries to the U.S. dollar functional currency. On an ongoing basis, we manage a portion of this risk by limiting our net monetary asset exposure to certain currencies primarily the Indian rupee in our foreign subsidiaries. 26



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We entered into a series of foreign exchange forward contracts that are designated as cash flow hedges of certain Indian rupee denominated payments in India. Our Indian subsidiaries, collectively referred to as Cognizant India converts U.S. dollar receipts from intercompany billings to Indian rupees to fund local expenses. These hedges to buy Indian rupees and sell U.S. dollars are intended to partially offset the impact of movement of exchange rates on future operating costs. For the three months ended March 31, 2014, we reported losses of $40.3 million, on contracts that settled during this quarter. As of March 31, 2014, we have outstanding contracts with a notional value of $2,040.0 million and weighted average forward rate of 57.8 rupees to the U.S. dollar. These contracts are scheduled to mature as follows: outstanding contracts with a notional value of $900.0 million and a weighted average forward rate of 54.4 rupees to the U.S. dollar scheduled to mature in 2014; outstanding contracts with a notional value of $900.0 million and a weighted average forward rate of 58.6 rupees to the U.S. dollar scheduled to mature in 2015; outstanding contracts with a notional value of $240.0 million and a weighted average forward rate of 67.2 rupees to the U.S. dollar scheduled to mature in 2016. Our foreign subsidiaries are exposed to foreign exchange rate risk for transactions denominated in currencies other than the functional currency of the respective subsidiary. We also use foreign exchange forward contracts to hedge balance sheet exposure to certain monetary assets and liabilities denominated in currencies other than the functional currency of the subsidiary. These contracts are not designated as hedges and are intended to offset the foreign currency exchange gains or losses upon remeasurement of these net monetary assets. We entered into a series of foreign exchange forward contracts scheduled to mature in 2014 which are used to hedge our foreign currency denominated net monetary assets. At March 31, 2014, the notional value of the outstanding contracts was $241.3 million and the related fair value was an asset of $2.3 million. During the three months ended March 31, 2014, inclusive of losses of approximately $8.4 million on these undesignated balance sheet hedges, we reported net foreign currency exchange losses of approximately $1.2 million.



Off-Balance Sheet Arrangements

Other than our foreign exchange forward contracts, there were no off-balance sheet transactions, arrangements or other relationships with unconsolidated entities or other persons in the 2014 and 2013 periods that have, or are reasonably likely to have, a current or future effect on the company's financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.



Critical Accounting Estimates

Management's discussion and analysis of our financial condition and results of operations is based on our unaudited condensed consolidated financial statements that have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the amounts reported for assets and liabilities, including the recoverability of tangible and intangible assets, disclosure of contingent assets and liabilities as of the date of the financial statements, and the reported amounts of revenues and expenses during the reported period. On an on-going basis, we evaluate our estimates. The most significant estimates relate to the recognition of revenue and profits based on the percentage of completion method of accounting for certain fixed-bid contracts, the allowance for doubtful accounts, income taxes, valuation of goodwill and other long-lived assets, valuation of investments and derivative financial instruments, assumptions used in valuing stock-based compensation arrangements, contingencies and litigation. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. The actual amounts may differ from the estimates used in the preparation of the accompanying condensed consolidated financial statements. For a discussion of our critical accounting estimates, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" in our 2013 Annual Report on Form 10-K. Our significant accounting policies are described in Note 1 to the audited consolidated financial statements included in our 2013 Annual Report on Form 10-K. There have been no material changes to the aforementioned critical accounting estimates and policies during the quarter.



Recent Accounting Pronouncements

See Note 1 to our unaudited condensed consolidated financial statements for additional information.

Effects of Inflation

Our most significant costs are the salaries and related benefits for our programming staff and other professionals. In certain regions, competition for professionals with advanced technical skills necessary to perform our services has caused wages to increase at a rate greater than the general rate of inflation. As with other service providers in our industry, we must adequately anticipate wage increases, particularly on our fixed-price contracts. Historically, we have experienced increases in 27



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compensation and benefit costs, including incentive-based compensation, in India; however, this has not had a material impact on our results of operations as we have been able to absorb such cost increases through price increases or cost management strategies such as managing discretionary costs, mix of professional staff and utilization levels and achieving other operating efficiencies. There can be no assurance that we will be able to offset such cost increases in the future.



Forward Looking Statements

The statements contained in this Quarterly Report on Form 10-Q that are not historical facts are forward-looking statements (within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended) that involve risks and uncertainties. Such forward-looking statements may be identified by, among other things, the use of forward-looking terminology such as "believes," "expects," "may," "could," "would," "plan," "intend," "estimate," "predict," "potential," "continue," "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, we or our 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 us with the Securities and Exchange Commission, or press releases or oral statements made by or with the approval of one of our authorized executive officers. These forward-looking statements, such as statements regarding anticipated future revenues or operating margins, contract percentage completions, earnings, capital expenditures, liquidity, plans, objectives, and other statements regarding matters that are not historical facts, are based on our current expectations, estimates and projections, management's beliefs, and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond our control. Our actual results, performance or achievements could differ materially from the results expressed in, or implied by, these forward-looking statements. There are a number of important factors that could cause our results to differ materially from those indicated by such forward-looking statements, including, but not limited to, a downturn in economic conditions in the United States and Europe; the loss of customers; the rate of growth in the use of technology in business and the type and level of technology spending by our clients; the risk of reputational harm to us; increased competition from other service providers; the risk that we may not be able to keep pace with the rapidly evolving technological environment; competition for hiring highly-skilled professionals or the loss of key personnel; the risk that we may not be able to control our costs or maintain favorable pricing and utilization rates; the risk that we might not be able to maintain effective internal controls; the risk that we may not be able to enforce non-competition agreements with our executives; the risk of liability resulting from security breaches; our inability to successfully acquire or integrate target companies; changes in domestic and international regulations and legislation, including immigration and anti-outsourcing legislation; the effect of fluctuations in the Indian rupee and other currency exchange rates; the effect of our use of derivative instruments; the risk of war, terrorist activities, pandemics and natural disasters; the possibility that me may choose to repatriate foreign earnings or that those earnings may become subject to tax on a U.S. basis; the possibility that we may lose certain tax benefits provided to companies in our industry by India; the risk that we may not be able to enforce or protect our intellectual property rights, or that we may infringe upon the intellectual property rights of others; the possibility that we could lose our ability to utilize the intellectual property rights of others; and the factors set forth in Part II, in the section entitled "Item 1A. Risk Factors" in this report. You are advised to consult any further disclosures we make on related subjects in the reports we file with the Securities and Exchange Commission, including this report in the section titled "Part I, Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Part I, Item 1. Business" in our Annual Report on Form 10-K for the year ended December 31, 2013. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as may be required under applicable securities laws.


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Source: Edgar Glimpses