Cognos, Inc. (NYSE: COGN) Analyst Report by Geoff Munger Manager, Student Managed Fund MBA Class of 2004 University of Connecticut Highlights Sector: Information Technology Industry: Computer Software and Services Valueline: Timeliness 3, Safety 3, Technical 4 Beta: 1.20 Market Cap: $3.111 Billion (Mid-Cap) Updated: October 29, 2003 Cognos, Inc. Data Sources: 3755 Riverside Drive Bloomberg Ottawa, Ontario Valueline Investment Survey Canada K1G 4K9 www.moneycentral.com Ticker Symbol: www.smartmoney.com COGN www.quicken.com Listed Exchanges: www.investopedia.com New York Stock Exchange (NYSE) www.investorwords.com Toronto Stock Exchange (TSX) http://finance.yahoo.com/?u Business Listings: Employees: 2,926 2002 Top 12 Most Influential Enterprise Software Companies by Intelligent Enterprise Magazine Selected as an index component of the Dow Jones Sustainability World Indexes for 2002. DJSI World was established to track the performance of the top 10% of the biggest 2500 companies in the Dow Jones Global Index which lead their field in terms of corporate sustainability. Metagroup (leading provider of IT research) ranked Cognos one of the 19 leading companies in business intelligence in a report dated April 2003. The leaders were selected based on their robust product lines and financial strength in the market. 1-Year Cumulative Returns Chart for COGN (compared to the S&P 500) Last trade 34.75 (10/29/03) Volume 485,962 Change +0.31 (+.90%) Average volume 848,100 Bid/Ask NA Mkt. Cap (million) $3.111 Billion Open 34.26 P/E 38.70 Previous close 34.44 Div. yield NA Day’s range 34.16 – 34.95 Annual Div./share NA 52-week range 19.50 – 35.33 Market NYSE Morningstar Stock Grades Growth A Profitability A+ Financial Health A Morningstar Recommendations Buy 10 Outperform 15 Hold 13 Underperform 1 Sell 1 Analyst Ratings Adams Harkness Buy SG Cowen Strong Buy WR Hambrecht Buy Pacific Crest Buy Company Overview Cognos Incorporated is a global provider of business intelligence software. The Company's solution helps improve business performance by enabling planned performance management, supported by effective decision-making at all levels of the organization, through the consistent reporting and analysis of data derived from various sources. Using its software, customers can plan and manage the performance of all aspects of their business and gain valuable insights that can be used to improve operational effectiveness, enhance customer satisfaction, accelerate corporate response times and, ultimately, increase revenues and profits. Its integrated solution consists of its suite of business intelligence components, analytical applications and performance management applications. Cognos is the only company to support all of these key management activities with a complete solution that spans all of the essential components of CPM—enterprise planning, scorecarding, and business intelligence. Business intelligence solutions make up 90% of Cognos’ revenue. Recent News___________________________________________ Earnings Cognos reported net income of $18.2 million, or 20 cents per share, for the quarter ended Aug. 31, up 32% from the same period a year ago. Sales were up 23% year over year to $158.2 million. In addition, Cognos has met or exceeded its earnings estimates in each of the past 5 quarters. Acquisition Cognos, Inc. acquired Adaytum, Inc. on January 10, 2003. The acquisition enhances its enterprise planning offering, an essential component of Corporate Performance Management (CPM) for large companies. Leveraging enterprise business intelligence with enterprise planning completes the Cognos vision for CPM. The ability to offer the full closed-loop CPM (planning, budgeting, monitoring, analysis, and reporting) cycle from a single vendor strengthens the value of our product offering and enhances the execution of our CPM strategy. This was a significant acquisition, but it had a minimal impact on the operating results during fiscal 2003, as it closed only seven weeks prior to the fiscal year end. Cognos anticipates that during fiscal 2004 and beyond, the acquisition will have a more significant impact upon operations. New Product On September 9 of this year, Cognos announced the worldwide launch of ReportNet, an all-in- one reporting software. Cognos ReportNet offers a Web-based report and query authoring environment, extensive multi-lingual support and Web Services-based architecture to meet the needs of today's multi-national, diversified enterprises and to dramatically reduce total cost of ownership. ReportNet has strengthened the relationship between Cognos and IBM and was selected within three weeks of its launch by IBM, Alfred Publishing, Pfizer Japan, First Citizens Bank, and Fujisawa, among others. For more information on ReportNet, see the following link: http://www.cognos.com/products/businessintelligence/reporting/index.html Cognos has more than 22,000 customers Global Customer Base 2002 (percent of revenue from each area) located in more than 135 countries. The numbers to the left are the percentages of 7% fiscal year 2003 revenues of $551 million North America in each of three major regions. 31% Europe Region 62% Asian/Pacific Region COGNOS BUSINESS SYSTEM ANALYSIS Product Design Development Usability Marketing Sales and Distribution •Conducts formal •World Leader in BI •Future Success usability testing in state •Complete and focused •Use an international, and Performance hinges on the ability of the art Usability Lab marketing effort divided multi-tiered channel Planning Software to continue to identify, into two groups: distribution system to hire, motivate and •Ensures products are •Customers in over Corporate Marketing reach customers on a retain skilled and tested by participating 135 different and Field Marketing cost effective basis experienced customers in their countries •Increasing Cognos •Support the channels personnel environments prior to •Offers a unique one- sale brand awareness and with an extensive •Formalized stop shopping visibility through organization of pre- solution for all key education practices in •Unparalleled customer advertising, events, and post- sales order to ensure new service accompanies sponsorship, website, specialists management staff are fully any purchase from activities (CPM – and sales collateral •Sales channels productive as soon as Cognos (awarded as Corporate possible one of the 10 best web •Marketing staff also include: Direct Sales Performance sites in North America responsible for sales (Primary target = Management) •Continued high for superior customer lead generation and Global 3500 investment in R&D to •Allows companies to support) local marketing Companies), Third- keep up with rapid programs such as trade Parties, and manage their full business cycle from change in the industry •Software is simple to shows, seminars, and Telesales manage, scalability to planning and •Aim at enhancing conferences. support hundreds of budgeting to reporting and extending their BI and analysis. solution and creating thousands of users and new products can be easily integrated with any application or environment Competition___________________________________________________ Company Ticker Timeliness Safety Technical Beta Scouter Ranking Cognos COGN 3 3 4 1.20 10 Incorporated Microsoft MSFT 3 2 3 1.15 8 Corporation Oracle ORCL 3 3 4 1.25 7 Corporation PeopleSoft PSFT -- 3 -- 1.50 6 Incorporated Siebel Systems SEBL 3 3 3 1.70 6 Inc. Timeliness, Safety, and Technical Ratings gathered from www.valueline.com. Beta information gathered from www.valueline.com. The Scouter Ranking information gathered from www.moneycentral.com. Growth Trends Revenue and Net Income: Revenue has been increasing steadily, Cognos Revenue and Net Income (over past 5 years) with the exception of a 1% decrease in fiscal 2002. Net Income has likewise 600 551 495.7 491.3 been increasing, except in 2002 when it 500 dipped significantly from $64.3 Million 385.6 (in millions) 400 301.1 to $19.4 Million. Revenue 300 Net Income 200 The results for fiscal 2002 include 58.4 58.8 64.3 73.1 100 19.4 special charges of $33.4 million. These 0 special charges include a net business 1999 2000 2001 2002 2003 restructuring charge of $10.2 million and a $23.2 million charge for settlement of a patent litigation action. Excluding the effect of these items, net income for fiscal 2002 would have been $43.4 million. Net Profit Margin Cognos Net Profit Margin Although Net Profit Margin declined (over past 5 years) during the years 1999-2002, the trend 25.0% has turned around. Cognos continues to 19.4% 20.0% 15.2% 15.0% 13.0% 13.3% show strong performance in fiscal 2004. 10.0% 3.9% 5.0% 0.0% 1999 2000 2001 2002 2003 Year Earnings per Share (EPS): Cognos is expected to significantly Projected 5-Year Grow th Rate outperform its major competitors over the 20.0% 18.2% 18.8% 18.0% next 5 years. Its EPS has increased 16.0% 13.7% 14.0% 11.9% 11.7% steadily, with the exception of fiscal year 11.0% 12.0% 10.0% 7.4% 2002. EPS is projected to increase from 8.0% 6.0% .81 in fiscal 2003 to .94 in fiscal 2004 and 4.0% 2.0% 1.12 in fiscal 2005. 0.0% t FT P el ry e s of no cl S& eb st S S ra og le du M Si O op C In Pe Management Performance Note when looking at the following charts: December 21, 2000 Cognos, Inc. reported weak fiscal third quarter earnings and warned that earnings for the fourth quarter of fiscal 2001 and for all of fiscal 2002 will be below expectations. The Company trimmed its profit outlook for each period by approximately 10%, citing decreased visibility as the primary reason for the anticipated shortfall. This significant announcement caused the stock price to plummet from $26.94 to $19.50 in one day. In addition, the numbers from fiscal 2002 were negatively affected by both an overall downturn in the software industry and the $33.4 million one-time charges incurred during that year. Return on Equity (ROE) (should be 2003) 2002 ROE (com pared w ith com petitors) Cognos was second among its major 40.00% 37.00% competitors in ROE in fiscal 2003, with a 35.00% 30.00% return significantly higher than that of the 25.00% 19.40% 20.00% 16.20% industry as well. Contrast this number with 15.00% 11.50% 10.00% 5.90% 7.90% Cognos’ ROA, which lags behind both Oracle 5.00% 0.00% 0.00% and Microsoft, though still outperforming the industry. This can be explained in part by the t FT P el ry e s of no cl S& eb st S S ra og le du M Si O op C In Pe low level of liabilities (including zero long- or short-term debt). ROE is therefore a more accurate depiction of Cognos’ return. The declining trend in ROE from 1999 to 2002 is Cognos ROE (over past 5 years) not as negative as it appears, and that trend has 40.0% 35.9% reversed itself. Cognos experienced decreases in 27.3% 30.0% 21.4% 19.4% net income as a percentage of revenue in fiscal 20.0% 6.6% 2001 and 2000 due to increased investment in its 10.0% 0.0% sales channels to focus on revenue growth and 1999 2000 2001 2002 2003 expand global market coverage. During fiscal Year 2001 the decrease in net income as a percentage of revenue was the result of increases in selling, general, and administrative expenses and the write- off of in-process technology acquired on the purchase of NoticeCast Software Ltd. during the third quarter. Finally, fiscal 2002 was negatively affected by an overall downturn in the software industry, but the results were exaggerated by the $33.4 million one time charges incurred in that year. Return on Assets (ROA) (should be 2003) 2002 ROA Cognos ROA (com pared w ith com petitors) (over past 5 years) 25.00% 21.40% 25.0% 20.2% 20.00% 20.0% 15.5% 15.00% 11.90%12.40% 15.0% 12.6% 11.1% 10.00% 7.90% 10.0% 3.7% 4.20% 5.0% 5.00% 1.30% -2.70% 0.0% 0.00% 1999 2000 2001 2002 2003 t FT P el ry e s of no cl S& -5.00% eb st S S ra Year og le du M Si O op C In Pe ROA is significantly lower than ROE because of the low level of liabilities held by Cognos. ROA exhibited the same negative trend during the years 1999 to 2002 as did ROE, with the same explanation. Return on Invested Capital (ROIC) 2003 2002 2001 2000 18.5% 11.6% 20.7% 26.9% Free Cash Flow (in millions): 2003 2002 2001 2000 379 52.5 -21.2 27.8 Interest Coverage: Interest Coverage is 146.4, while the Industry average is -97.7. This is due to the fact that Cognos has no debt, either short- or long-term. Stock Valuation: Updated 2/1/04____________________________________ P/E Ratio: P/E Ratio is currently 32.5, compared to the Industry average of 47.5. This can indicate that the stock is undervalued, and that its profits are rising disproportionately to its price, especially considering the high projected growth over the next 5 years. Alternatively, however, a lower P/E can also indicate that investors do not have confidence in the stock’s potential for future growth. In this case, the former is more likely due to the strong performance of Cognos over the past two years and the increasingly positive news regarding its product line and growth potential. PEG COGN MSFT ORCL PSFT SEBL INDUSTRY 1.87 1.94 2.6 1.78 3.35 8.74 The PEG ratio (price-to-earnings growth) is calculated by dividing a stock's forward P/E by its projected three- to five-year annual EPS growth rate. It is used to find companies that are trading at a discount to their projected growth. A PEG ratio of less than one is considered a sign that a stock is a good value. Generally speaking, the higher the PEG, the pricier the stock. Though Cognos does not have a PEG of less than one, its PEG is lower than that of its competitors (other than PSFT) and of the industry. Financial Health Capital Structure: Cognos has no short or long term debt. Equity Capital Structure Debt Capital Structure Market Capitalization = $3.111 Bn Short-term debt = 0 Preferred equity = 0 Long-term debt = 0 Common Weight = 100% Short Debt Weight = 0% Preferred Weight = 0% Long Debt Weight = 0% Cost of Equity (CAPM Model) CAPM = Rf + beta(Rm-Rf) Rf = risk free rate (5 year treasury bond rate) = 3.27 (www.forecasts.org 2/1/04) Rm = 7.90% Rm - Rf = historical long term equity risk premium (market risk) = 4.63 Beta = 1.25 CAPM = 3.27 + 1.25(4.63) = 9.06% Cost of Equity for COGN = 9.06% Cost of Debt for COGN = %0 Cost of Preferred Stock for COGN = 0.0% WACC = (% of equity*cost of equity) + (% of debt*cost of debt) = 9.06% ROIC = 18.5% SPREAD = 18.5% - 9.06% = 9.44% Average Annual Compound Growth Rates 10-year EPS growth 24.98% 10-year DPS growth N/A Earnings growth fell drastically in 2002 but has recovered and posted even stronger growth than it had shown prior to Cognos’ significant one-time charges incurred in 2002. Dividend growth is not relevant as the company has never declared dividends. Average Plowback, Payout, and ROE (10-year) Average Payout 0.0% Average Plowback 100.0% Average ROE 21.10% Growth Rate 10-year EPS 24.98% 10-year DPS N/A ROE*b 21.10% Average of 2 growth rates 23.04% P/E Valuation Model Avg. P/E 40.60 BUY Projected Earnings 2004 .95 Projected Price 38.57 COGN is currently trading at just above $30. Thus, the P/E Model implies that the stock is undervalued. ValuePro.net Intrinsic Value For the time being, intrinsic value was taken off of ValuePro.com, using the following assumptions: Growth Rate: 18.2% 10-year Treasury Yield: 5.0% Beta 1.20 Current Price 30.22 BUY Intrinsic Value 38.45 According to this calculation, despite the stock’s rapid growth in the past year, there is still room to continue to see increases in price. ValuePro’s default settings value COGN at $46.44. Stock Rankings Timeliness Safety Technical Beta Valueline 2 3 3 1.25 MoneyCentral StockScouter Rating: 7 MoneyCentral Average Analyst Recommendation: Moderate Buy Yahoo!Finance Average Analyst Recommendation: Hold The Company Board Board of Directors 1 linked, 7 independent John Caldwell – Independent: Independent Consultant since November 2002. Consultant to GEAC Computer Corporation Limited, from December 2001 to October 2002. President and Chief Executive Officer of GEAC, from October 2000 to December 2001. Private Investor from October 1999 to October 2000, and President and Chief Executive Officer, CAE Inc., from June 1993 to October 1999. Currently a Director of Faro Technologies Inc., Mosaic Group Inc., SMTC Corporation and Stelco Inc. Paul Damp- Independent: Managing Partner, Kestrel Capital Partners, an investment firm, since January 1990. Vice-Chairman of AIT Advanced Information Technologies, Inc., a provider of systems for the issuance of machine-readable travel documents, from September 1999 to July 2002 Non-executive Chairman, Architel Systems Corporation, a telecommunications software provider, from June 1998 to June 2000. Chairman and Chief Executive Officer, Accugraph Corporation, a telecommunications software provider, from October 1996 to June 1998. Currently a Director and non-executive Chairman of Davis and Henderson Income Fund and Director of Home Equity Income Trust. Pierre Ducros- Independent: Private Investor since June 1996.Chairman and Chief Executive Officer, DMR Group Inc., from February 1973 to June 1996. Currently a Director of BCE Emergis, National Bank Financial, Manulife Financial, eNGENUITY Technologies and nStein Technologies. Robert Korthals- Independent: Chairman, Ontario Teachers Pension Plan Board since January 2000 and Chairman, Gerda Ameristeel Inc.(formerly Co-Steel Inc.), since June 1997. Currently a Director of Jannock Properties Limited, Mulvihill Premium Global Telecom Corp., Mulvihill Premium Split Shares Corp., Mulvihill Premium Canadian Bank Corp., Rogers Communications Inc., RTO Enterprises Inc., and Suncor Energy Inc. John Rando- Independent: Chairman, Storability Software Inc. since January 2002, Chairman ecora Software Corporation since March 2000, and Chairman, @Stake, Inc. since November 1999. Partner, Flagship Venture Partners, NewcoGen Group, from November 1999 to November 2002. Senior Vice President and Group General Manager, Compaq Services at Compaq Computer Corporation, from June 1998 to July 1999. Senior Vice President, Worldwide Services at Digital Equipment Corporation, from January 1993 to June 1998. Currently a Director of ePresence Inc. William Russell- Independent: Vice President, Global Alliances, Hewlett-Packard Company, since May 2002. General Manager, Software Solutions Organization, from September 1999 to May 2002 Vice President and General Manager, Enterprise Systems Group, from May 1997 to September 1999. James Tory- Independent: Board Chair of the Corporation since September 1995 Chair Emeritus and Counsel, Torys LLP, lawyers, New York and Toronto, since March 1995 and previously a partner in that firm. Currently a Director of Inmet Mining Corporation. Renato Zambonini- Linked: Chief Executive Officer of the Corporation since September 1995 and President from January 1993 to April 2002. Currently a Director of The Reynolds and Reynolds Company. Risk Analysis Insider Trading: No insider trades dating back five years. Current Risk Factors: Unexpected changes in regulatory requirements for software Social, political, labor or economic conditions in a specific country or region (including foreign exchange rates) Difficulty in staffing and managing foreign operations High competition for skilled employees in the software industry Increase in unlawful copying and distribution of software Increasing competition and rapid technological change in the software industry Lawsuits that could potentially have an adverse effect on the business – declines in revenues, operating margins, and net income Short sales cycle therefore limited order backlog – quarterly results can vary significantly Heavy reliance on business intelligence revenues
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