高知特 (CTSH) 2002 Q1 法說會逐字稿

Good morning. My name is and I will be your conference facilitator. At this time, I would like to welcome everyone to the Cognizant Technology first quarter 2002 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. If you would like to ask a question during that time, simply press star, then the number one, on your telephone keypad. And questions will be taken in the order they are received. If you would like to withdraw your question, press star, then the number two, on your telephone keypad.

Thank you, Mr. , you may begin your conference.

Thank you, , and good morning, everyone. By now you should have received a copy of today's press releases. If you haven't, please call Morgen-Walke at 212-850-5752. On the call today we have Kumar Mahadeva, Chairman and CEO, and Gordon Coburn, Chief Financial Officer of Cognizant Technology.

Before we begin, I'd like to remind you that some of the comments made on today's call and some of the responses to your questions may contain forward-looking statements. These statements are subject to risks and uncertainties as described in the company's earnings release and other filings with the SEC.

And now, let's turn the call over to Kumar. Please go ahead.

Thank you and good morning. I'm pleased you can join us today as we report record results and renewed sequential growth. Our revenues increased seven percent year over year, as well as over the fourth quarter, to $46.5 million. Net income for the first quarter increased to $7.1 million or 35 cents per diluted share, from 5.6 million or 28 cents per diluted share in the first quarter of 2001. This includes the tax benefit of six cents a share from the company's new tax rate of 24.5 percent, based on our strategy of using Indian generated earnings for international expansion.

For the foreseeable future, our major investments will be overseas, including geographic expansion in Europe and Asia and the addition of new delivery capacity in India at new technocomplexes in Puna, Calcutta and Chennai. And we plan to reinvest all of our future Indian income for these purposes.

Although we have always enjoyed a tax holiday on our Indian income, we have, in the past, accrued taxes on this income, based on the assumption that the earnings will be . With the old tax rate, pro forma net income for the first quarter was $5.9 million or 29 cents per diluted share, ahead of Wall Street consensus.

Our sequential growth was strong this quarter and will remain so because of our high win rate. Growth was driven, primarily, by the ramp up of large clients that we won in the last year. Over this period, we participated in offshore partner selection processes run by 42 Fortune 500 type corporations. And Cognizant was selected as a partner in 59 percent of these cases. The initial list of competitors typically included the offshore leaders as well as a large number of second tier players. Domestic companies with offshore capabilities were also represented in more than half the deals.

Most of our wins are still in the early stages of their ramp up cycles and our clients have ambitious targets for expanding their offshore programs through the remainder of this year and in 2003, giving us a high level of optimism for continued growth. At the same time, the pipeline for new deals remains extremely strong, providing further upside.

Over the last year, we've seen a change in the nature of the offshore market. No longer a side option for pioneering project managers, offshore has gone mainstream in the Fortune 500, driven top by CEOs and CIOs with ambitious targets for business performance improvement. Cognizant's ability to sell effectively at the sea level and its bottom line business orientation has paid off in the new market, as we have won deals away from our competitors.

For example, a sophisticated knowledge transfer and change management capabilities feed the ramp up of offshore deals. This is a distinct competitive advantage for Cognizant as larger volumes of work can be rapidly moved offshore to better meet the demands of clients. We also have sophisticated portfolio analysis tools to quickly identify all systems through the for offshore outsourcing and to uncover opportunities for further cost savings through systems consolidation or replant forming.

For example, for a large global retailer with 122 stores worldwide, we were able to take over and support of 200 different systems serving different country markets and drastically reduce their support costs by consolidating worldwide support at one of our centers in India. We are not in the process of rearchitecting to a single new global platform that will give our clients the ability to further cut costs by reducing support requirements and improving business processes. The new platform will also give them the flexibility to launch several new revenue growth initiatives.

Another reason for our success is our extremely high customer satisfaction. Every year we have the satisfaction of our customers independently assessed by , a market research firm specializing measuring customer satisfaction. The just completed survey shows the satisfaction at 4.5 on a five-point scale, up from 4.11 last year and our best ever. Highly satisfied customers give us more business and serve as extremely strong references, helping us win new deals, driving a virtuous cycle of growth.

Much of the action in the last 12 months has been in application management outsourcing. However, we are also having a high success rate at cross selling high-end development integration services through application management clients. Increasingly, development and integration work involves the extension of cooperational systems to improve business processes of customer and supply relationship management. As custodians of the cooperational systems, companies like Cognizant have a built-in advantage. The investments we have made in industry specific solutions, technology architecture and enterprise applications is paying off and we have recently won several new assignments.

One example is a recent win - a multibillion-dollar pharmaceutical company, which has been an application management plant for some years. We were recently engaged by this client to develop a CRM strategy, aligned with their overall business objectives and to build and implement the system to accomplish these objectives. The CRM system is state-of-the-art and will eventually bring together sales, marketing and service on one platform. This business critical project is driven by the client's CEO and CIO and is a core part of the client's next generation business architecture. We won this assignment against nine competitors, including several of the big five.

Looking deeper at the customer base, health care grew in absolute dollars this quarter and now accounts for 27 percent of revenue. I'm particular pleased that our HIPAA experience is gaining traction and we are now working on four engagements. We have a proven HIPAA methodology, HIPAA program management expertise and a proprietary tool suite. We are strongly positioned for HIPAA because of our strong understanding of health care business processes and our expertise in core processing operations, which we have gained by becoming the leading implementer of , the industry leading managed care application from .

Our financial services vertical experienced the strongest gains, based on a number of important wins in the last year, including MetLife, Providian and a large money center bank. All the financial services customers also continued to expand their relationships with us. Financial services is now 29 percent of revenues. Our manufacturing vertical made great strides over the last year with the addition of new clients such as GM. Retail manufacturing and logistics now account for 17 percent of revenues.

In summary, we are extremely please with the turnaround in our business this quarter and see this as a trend that will continue. We are now comfortable with forecasting revenues of at least $49.5 million and EPS of at least 30 cents in the second quarter. We are also extremely comfortable with reaffirming our full year guidance of at least 200 million in revenues and at least $1.50 in EPS, based on the new tax rate.

I should mention that our pipeline remains very strong and we have seen some recovery in development spending. And should these trends continue, there will be upside to our guidance in the second half of the year. And we can look forward to a strong 2003. And with that, let me turn you over to Gordon.

Thank you, Kumar, and good morning to everyone. I would like to provide some additional information on the first quarter and then discuss our financial expectations for Q2 and beyond in more detail. Revenue for the first quarter exceeded our expectations and represented the largest sequential increase in quarterly revenue in over a year. In addition, revenue in Q1 was the highest quarterly revenue in our history. All of our core businesses remained very solid. We experienced growth in our key verticals. Our pipeline in robust. And we are confident in our ability to continue to deliver healthy sequential revenue growth during the remainder of this year.

Both application management and application development grew sequentially in Q1. During the quarter, our application management services represented 55 percent of revenue. Application development and reengineering was 45 percent of revenue. E-business, which is contained primarily within our application development and reengineering category was approximately 26 percent of revenue.

We continue to penetrate our vertical markets, with 29 percent of revenues coming from financial services, 27 percent from health care, 17 percent from retail manufacturing and logistics, 13 percent from information services and two percent from telecom. The remainder of our revenues came, primarily, from other service-oriented industries, as well as our alliances. In the first quarter, we moved an existing customer from being included in our information services sector to our financial services sector. This change positively impacted financial services revenue by $1.6 million and reduced information services revenue by an equal amount.

We added seven new customers during the first quarter, including two Blue Cross health care organizations, a large insurer, a major bank and a Fortune 200 manufacturer. Our active customer base is approximately 95.

Turning to costs. Costs of revenues increased eight percent for the quarter as compared to the first quarter of 2001. The increase is almost entirely due to additional technical staff, both onsite and offshore, required to support our revenue growth. We increased our technical staff by approximately 440 people, compared to the first quarter of 2001 and ended the quarter with 3,400 technical staff.

In addition, during the first quarter of this year, the percentage of work delivered onsite increased on a sequential basis, due to the short-term knowledge transfer activities associated with the rapid ramp up of several of our newer clients. We delivered approximately 29 percent of our services onsite in Q1, compared to 27 percent in the fourth quarter of last year. The higher salary costs associated with onsite personnel contributed, in part, to the sequential increase in cost of revenues.

Gross margin was 48 percent, a decrease of 50 basis points compared with our gross margin in the first quarter of 2001. As we indicated in our guidance during the last earnings call, with the ramp up of higher volume consulting and integration services, combined with the slight shift towards onsite work, which I previously mentioned, we saw a slight compression in our gross margin this quarter.

SG&A expenses, including depreciation, were 13.1 million, up from 12.6 million in the first quarter of last year. As a percentage of revenue, SG&A was 28.3 percent, a decline of 80 basis points in the first quarter of 2001, resulting from our ability to leverage last year's sales and marketing investment, as well as continued cost controls. Operating income for the quarter increased nine percent to 9.1 million, from 8.4 million last year. And our operating margin was 19.7 percent, down approximately 110 basis points from the fourth quarter of 2001 and up 40 basis points from the first quarter of 2001.

As we discussed during our last earnings call, due to revenue weakness late last year, we adjust our cost structure during the fourth quarter and reduced our anticipated bonus liability for 2001. This allowed us to deliver unusually strong operating margins in the fourth quarter of last year.

During the first quarter of this year, our bonus liability returned to a normalized level, resulting in operating margins returning to historical and, we believe, sustainable levels. Interest income for the first quarter was 429,000, compared to 746,000 for the first quarter of 2001. Interest income declined despite higher cash balances, due to a significant drop in short-term interest rates. We had $160,000 foreign exchange loss during the quarter, due to the devaluation of the India rupee.

As Kumar mentioned earlier, our tax rate declined to 24-and-a-half percent in Q1. The reduction in the tax rate resulted from the company's decision to use its 2002 and future India-based earnings for long-term reinvestment outside the United States. We believe that this tax rate is sustainable for the foreseeable future.

This change occurred at this time for several reasons. First, we have recently identified ways through which we can use our India cash to fund investments for India's international strategy, including acquisitions outside the United States, allowing us to fund such investments using pretax dollars from India, instead of after tax dollars from the U.S.

And second, we continue to invest heavily in our infrastructure in India, resulting in a permanent use of a portion of our cash in India. We see an increasing need to do non U.S. acquisitions to be well positioned for an expected increase in acceptance of and demand for offshore services in northern Europe. This demand wave has already hit the United States and we think Europe is next. The acquisitions we are looking for in Europe are, ideally, relatively small in nature, but will give us critical mass and a greater local presence through which we can leverage our offshore services.

Turning to the balance sheet. We finished the first quarter with $91.2 million of cash, an increase of 6.2 million for the quarter. During the first quarter, operating activities generated seven-and-a-half million of cash. Financing activities, specifically, the exercise of stock options, generated an additional $700,000. These amounts were partially offset by approximately $2 million of capital expenditures, including expenditures for our India construction program.

During the fourth quarter of last year, we opened the first of three new company-owned development centers in India. The first facility, located in Puna, is 135,000 square feet and will house close to 1,000 programmers. In the fourth quarter of this year, we expect to open the second of our three technocomplexes. The second facility, located in Calcutta, will be 115,000 square feet and will house close to 1,000 programmers, as well. The third technocomplex, located in Chennai, will contain 370,000 square feet and will house close to 4,000 programmers. This facility will start to come on-line in early 2003.

Our trade receivables during the quarter was strong once again. Based on our $29.8 million trade AR balance in March 31, we finished the quarter with a DSO, including unbilled receivables of approximately 58 days, well below our targeted DSO of 70 days. We are particularly pleased with our March collections, in light of the current economic climate. Excluding unbilled receivables, our DSO was 46 days.

The unbilled receivable balance increased during the quarter by $600,000 to six million. This increase resulted from the company's continued effort to ship more of its work towards fixed price contracts. During the quarter, 27 percent of our revenue was from fixed price contracts, compared to an average of 24 percent last year. Our fixed generally have quarterly billing milestones. Approximately 50 percent of our March 31 unbilled balance will be invoiced this month.

Turning to headcount. At the end of the first quarter, our worldwide headcount, including both technical professionals and support staff, totaled approximately 3,835. This represented a decline of 90 people during the quarter. Annualized turnover was 19 percent for the first quarter, including both voluntary and involuntary. Voluntary turnover was approximately five percent annualized. And involuntary turnover was 14 percent annualized. The spike in involuntary turnover during the quarter resulted from the completion of our transition in technical capabilities, to meet the shift in market demands towards application management.

Utilization during the first quarter increased to approximately 90 percent onsite and above 60 percent offshore. Utilization increased steadily throughout the first quarter and we expect that trend to continue in Q2. We have recently accelerated our hiring plans in India, in response to the strong demand we are seeing for outpatient outsourcing.

I would now like to comment on our growth expectations for the second quarter and beyond. We are comfortable with our ability to deliver revenue in the second quarter of at least $49-and-a-half million. We continue to have significant revenue visibility, due to the high level of recurring revenue and the long-term age of our customer relationships. In fact, today we have customer commitments for well over 90 percent of our second quarter revenue guidance and over 80 percent of our Q3 expectations.

During the second quarter, we intend to continue to closely monitor our spending and expect our operating margins in the range of 19 to 20 percent, in line with our - in line with our historic margin level and prior guidance. Based on this expected level of revenue growth and our expected operating margins, we are currently comfortable with our ability to deliver EPS of at least 36 cents during the second quarter.

Looking at full year 2002. Based on existing customer commitments, recent application management wins and a review of our sales pipeline, we are comfortable with our ability to deliver at least $200 million of revenue. We are optimistic about this year, based on continuing success and expanding relationships with our existing customers and winning new customers who have identified offshore services as a strategic component of their technology strategy. Based on this level of revenue growth and our expected operating margins, we remain comfortable with our ability to deliver at least EPS of $1.50 for the full year.

Now, Kumar and I would like to open the call to questions. Operator?

At this time, I would like to remind everyone, in order to ask a question, please press star, then the number one on your telephone keypad. We'll pause for just a moment to comply the Q&A roster. Your first question comes from .

Hey, Gordon. It's ...

Hi, .

... from Goldman Sachs. I never heard my name pronounced quite that way. Quick question. Can you - can you just walk us back through the construction phase that you guys just went through - the Puna, Calcutta, facilities? And then, maybe, in addition to that, give us some perspective on, you know, I think you talked about the international expansion, but I just want to make sure that I've got the complexes that you're talking about now versus the ones that have already been - the processes that have already been sort of undergoing as far as the build out is concerned. I just want to make sure I have all of that straight in my head here.

Sure. Let me take the first part of the question. Then I'll turn it over to Kumar. It's one and the same for construction. We're building three new technocomplexes. The first one is already complete and occupied. That's in Puna. That came on-line at the end of last year and has capacity to house about 1,000 people.

Last year. Great.

The second facility is in Calcutta. That's currently well underway. The show's almost complete.

OK.

That'll be occupied by the end of this year and that will also, at capacity, hold about 1,000 people. And then, on our third technocomplex, which is a little larger than we originally anticipated, in terms of the size of the facility, we just broke ground on a facility that will be about 370,000 square feet and hold 4,000 people in China. That facility will actually come on-line in two phases. The first phase of which will come on-line very earlier in 2003 and then the second phase, late 2003 or earlier 2004.

2003. OK. And what is the incremental change, then, with regards to the investment that you guys are going to now be making with ...

The total investment, including the cost for the show, for the fit out and for the hardware to go into the facility, in total, will be right around $40 million, including the stuff that's already been built.

Including what - OK.

Including the Puna facility which was built last year.

Right. OK.

No. I mean, realize that this assumes an expansion to about 6,000 people in India over the next few years. So, that's sort of the growth on which this is predicated.

Got it. OK.

In terms of acquisitions, , the focus, really, will be on small acquisitions that build up presence primarily and initially in Europe, focusing on UK, , possibly Scandinavia, where - which we see as the initial market square offshore because of language issues and other things - will take of the fastest. So, we've been actively searching for those acquisitions and we hope that we can get some done this year.

OK. Great. And then, just real quickly, can you talk a little bit about - you know, you indicated that cross selling was helping you guys out in terms of actually showing some good growth here on a sequential basis in the application development side of the world, which was a little bit better than what we were looking for here. So, maybe you can just help us understand where you guys are in terms of effectively cross selling. Maybe if there's any metric that you could share on that regards, I would appreciate it.

Yeah. Sure. Well, one of the interesting metrics is, I think, we resumed sequential growth after a long and large number of quarters of decline in development and integration in dollar terms. We saw fairly good growth in the first quarter. And we - that's something we see continuing. So, you know, we see that as early signs of a turnaround in the development and integration business.

And most of it, really, does come from my existing clients. And, as I mentioned in my comments, it's - we've been fairly active in having won the application management deals going back to these clients. And engaging them on opportunities, both to reengineer the systems we are maintaining, to increase their functionality. And on areas like CRM, where we built practices recently.

Do you have a percentage of like - of the 95 clients that you guys currently have on-line - percent that you currently cross sold to or along those lines?

I'm not sure I have that ...

But it's going to be all of the larger clients we do both development and maintenance services for.

Yeah. I would say that it's a rare client in which we do not cross sell some development and integration services. Over time, our target is to make the revenue stream roughly 50-50 from each of the clients. We're not there yet with some of the newer clients. But I think there are very few we are not doing any development and integration work.

Great. Thank you, very much.

OK.

Thanks, .

Your next question comes from .

Hey, Kumar. Hey, Gordon.

Hi, .

Nice job on the quarter.

Thank you.

A couple just - housekeeping questions if I could. Can you give us, Gordon, the bill rate onsite versus offshore? And with that percentage to the 45 percent of revenues that you gave us on the apps development side, what's the breakout of development versus the engineering?

Sure. Billing rates were essentially flat with fourth quarter. So we were right around 70 bucks and hour on site and about $24 an hour offshore. So, very consistent with fourth quarter.

OK.

When we look at breaking out the 45 percent of outpatient development, it was - 43 percent was development and two percent was reengineering.

OK. I mean, what's the expectation on the engineering side as you look out this year? Is that a business that's just going to be folded into the development business?

Clearly folded. It's very tough to distinguish the two. And that's why, you know, other than that, just, you know, so your can keep miles straight. We really do view development as development, reengineering, all combined.

Yeah. I'm not even sure that - I'm not sure exactly how we would classify that. I would combine those two because they have a lot of - there were - as I said, most of the development work we do today is really taking legacy systems, integrating with them new things, some amount of reengineering. So, the classification becomes quite difficult.

It's very gray. And that's why we combine the two.

OK. And the net ads in India this quarter - what was that?

You talking headcount?

Yeah.

Headcount was down compared to fourth quarter by 90 people worldwide.

Within India, were you actually net down, as well?

Yeah. Certainly. Because onsite ...

OK.

Because we shifted more onsite during the quarter.

And embedded in, I guess, your guidance, what does that assume in terms of overall hiring or hiring in India versus the U.S.? Can you give us any more color there, Gordon?

Yeah. In terms of overall hiring, it's dependent of what level of upside we see as the year goes on.

Right.

You know, we have - you know, we'll bring on seven or 800 people from campuses in the June, July time-frame. The big question is how much lateral hiring do we do? We recently, in the last month, significantly increased our level of lateral hiring because of the demand we're seeing and the ramp up in the current quarter that we need.

But where we end up the full year will depend on how strong the back half is. You know, and, you know, the signs are it could be reasonably strong, as this point.

Yeah. I think, , the hiring embedded in our current guidance - we really don't need a lot more people to do our current guidance, but it looks like the divide is going to be significantly stronger than that. So, we are, you know, based on the pipeline, we are hiring very aggressively.

OK. And on the growth by verticals. The strongest growth, you mentioned, was in financial services. What's kind of the relative growth rate for the rest of the verticals, I guess?

Well, health care is also growing at fairly healthy clip. Information services is a more mature category for us, obviously.

Right.

So, even, you know, adjusting for the customer that we moved, information services was down slightly, sequentially. But health care, financial services are both doing well. We're making very nice progress in manufacturing and logistics in the retail segment. So, I'm not sure there's one ...

OK.

... there really are no trouble spots. But if you look at the brightest spots, it's financial services and health care.

OK. And just one last question and I'll hand it over. In terms of Europe expansion plans. I guess, what's really - what do you see - and I guess, that's really making you need to push aggressively into Europe? Is it some of your existing customers that are really significantly ramping up projects both in the U.S. as well as in some of the projects that you're doing in Europe?

Yes. Absolutely. The - one of the things we are finding is that the deals we are winning now tend to, very quickly become global. So, you know, the money center bank deal we mentioned extending worldwide into Europe and elsewhere. First Data Corporation, which has been a longstanding client, is now, you know, asking us to move into Europe. So, intrinsically, the U.S. clients are taking us into Europe. At the time, we'd like to build on that momentum by adding a base of domestic, you know, a European headquartered clients. And that's really where acquisitions will be targeted is acquiring some of the European headquartered clients.

OK. Congratulations, guys.

Thank you.

Thanks, .

Your next question comes from .

Hi, Kumar and Gordon.

Hi, Pat.

My question deals with the pickup in the HIPAA pipeline. Could you just give us some more commentary on that? I'm intrigued, after all the delays we've had with HIPAA, that we're starting to finally break the logjam. Thanks.

OK. Again, I wouldn't describe, but - describe it as a flood at this point. We - what we are pleased with is that the engagements we are working on are developing into more end to end types of engagements, whereas for the last year, we were merely doing assessments for a large Blue Cross plan. We just did a remediation phase which was about $3 million. We just started three others, which could end up being in the same range, though the initial stuff they're doing is not that large.

So, I think what we are pleased about is not that the floodgates have opened, but that we are seeing real tangible HIPAA implementation deals as opposed to just assessments going on.

And how's the pipeline of additional new potential HIPAA clients?

There's a good pipeline. Again, I don't think it's going to be a huge revenue stream until the back half of this year. So, but it does look real now and we have a sense for how big these deals are. So, I think I feel more comfortable talking about that to the real business as opposed to just a concept.

Thanks.

OK.

Thanks, Pat.

Your next question comes from .

Hi, guys. .

Hi, Andrew.

My question is about price environment. For a long time, sort of, the high quality guys were around the same pricing, with emphasis a little above. My sense is sort of Infosys is now lined up with your current pricing. Has that changed your pricing strategy? What's sort of the competitor pricing environment now for new work?

Well, I think, Andrew, you are exactly right. I - our sense is that like people like Infosys who used to price at something of a premium to us have, essentially, come down to essentially around the same price. However, our win rate, as I mentioned to you, has remained extremely high. So, we haven't seen the need to significantly lower our prices, you know, except in correlation to volume, you know, where we given the sort of same sort of volume discounts that we've always given. The only thing is that the deals these days do tend to be bigger.

But the pricing environment, really, has remained fairly stable for us. There are a bunch of second tier players who price much more aggressively, much lower than any of Cognizant or Infosys or any of the others. But, at this point, they don't seem to be winning the deals. So, they haven't destructed the markets.

And with the pickup in the demand stream and with the pickup of the pipeline, we're reasonably optimistic that the pricing environment will stabilize or improve because, clearly, the extreme softness we saw in the last couple of quarters is gone.

Do you have any sense, when you look at your sort of revenue projections, where price will play into that? Should it be a drag this year or might it be mutual?

The - where pricing plays into it is, as we're moving more towards application management, even though we saw a little bit of spike in work moving onsite. As we finish knowledge transfer, it will move back offshore. So, it does mean we have to do more volume for the same revenue. But, you know, so the average price - blended price - will come down a little bit because of the onsite, offshore mix. But, you know, I think pricing - actual prices onsite and offshore will remain pretty stable as we go through this year.

That's an important point, though, Andrew. With application management, the onsite, offshore ratio tends to be more like 20 to 80 or even higher percentage offshore. So, you see, sort of, the blended rate, if you like, coming down a little bit. But the profitability will, if anything, be the same or higher that it has been in the past.

And the actual rate for onsite and the actual rate for offshore, I think, will ...

Will remain pretty much the same.

Just one more last detail on this. How long do you think, for how many months, could you have called the sort of competition on price as stable for, you know, the quality players?

I'd say it sort of really started to stabilize this quarter. I think some of the prices, you know, came down fairly dramatically, starting second quarter of last year, down - through to the fourth quarter.

To be clear, what Kumar said this quarter - in the first quarter.

In the first quarter. Yeah.

OK. Thanks, guys. Much appreciated.

Thank you.

Your next question comes from .

Hi. Good morning. Gordon, if you could just go over the new tax structure here. Just some specific question on it. Is there a percentage of earnings that you have to invest from your total India operations to get the lower tax number?

No, to get the lower tax number, all we have to do is not bring the money back. So, as long as the money stays in India, the tax rate is effective. And, you, one of the things to remember - we already have $70 million of India income, which we can bring back, which was income prior to 2002. So, you know, we don't really see any issues with maintaining this new lower tax rate.

OK. OK. But there's not a percentage that you have to invest in order to get there? So, it could ...

Not that we have to invest.

OK. OK.

What we have to do is not bring the money back to the U.S.

OK. OK. Because - all right. That's ...

But, you know, in theory it could just sit in India.

I think we would just - the new tax rate really reflects what has been economic reality for some time, that we were not taxed on the India income and, frankly, most of our investments have been outside of the U.S. So, it really reflects better, I think, the economic realities and also makes us more comparable with competitors.

So, what's changed between, you know, the past couple years when you've been accruing at 37.4 percent or so and today?

Well, you know, we've taken a fairly conservative assumption in the past that we would bring everything back. You know, with the benefit of experience, we've found that mostly, the investments are overseas. And as I mentioned to you, we are doing specific things - like the technocomplexes and acquisitions. So, we've done a fairly detailed analysis of our cash flow and feel very comfortable that, over the next three to four years, we will be investing all the India generated income. Now, you know, realize we also generate income in the U.S. But the India generated income that we will be able to - will be reinvesting that in Indian capacity expansion plus overseas acquisitions or just marketing offices and so on.

OK. It sounds good. Now, what happens to the money that's already been accrued for taxes in prior years at the 37 plus percent rate?

That we can bring back at any point in time that we want. When we do bring it back, we would pay tax on it. It would not hit the P&L, since we have a deferred tax liability. So, at our discretion, we can bring that back.

Why would you bring it back? What would be a reason for doing it?

I'm not sure there's an immediate need, but, you know, if we want more cash in the U.S. or if we want to manage our foreign exchange exposure. You know, to date, we haven't brought it back. But, you know, we certainly want the ability to bring that back. And if we - if we did, at some point, bring it back, we'd probably end up with a little too much cash overseas.

OK. So, it's just a nice cushion if you need it, I guess.

Exactly. Right. We don't see any immediate need, but, you know, we have the flexibility. So, between that ability, we'd bring that existing 70 million, that that gives us a lot of flexibility in the next few years.

OK. Now, last question on the tax and then I want to move onto something else. But the - I assume that because this is a permanent change, that, Gordon, you will be releasing numbers at 37.4 percent or don't expect guidance to come? Do you expect guidance, now, to include the new tax rate? Is that a safe assumption?

Oh, absolutely. You know, we talked about the pro forma numbers this quarter, just so people could understand that, even without the tax change, we beat our numbers. But, going forward, we will only talk about the business, using the new tax rates, since that reflects the real business. This is not a one-time thing. This is a permanent change.

OK. Good. OK. Then, moving forward to the strategy about Europe and Asia and the expansion there, I assume you guys are being pretty, you know, being prudent and so forth and looking at things. But what kind of timing can we expect with some acquisitions or some new strategic moves into other areas of the world?

Well, we have, in fact, we just opened an office in Singapore, partly to support some clients who wanted business there. We are in the final stages of trying to an alliance in Japan. Hopefully, that would work out. And, in terms of European acquisitions, we are, you know, very actively looking - we must have looked at 30 or 40 deals last year. We're looking at many more this year. So, you know, we, obviously, are very selective and very careful and we want to do relatively small deals.

What we're really trying to buy are clients in the right industries, client relationships. And we want the right type of client relationships. So, we don't want to buy staffing companies, which have very small relationships. We also want - don't want to do very large acquisitions, which would involve big integration issues.

So, that does make it a little harder. But, hopefully, in the course of this year, we can get some deals done.

OK. Sounds good. And then, I guess, my last question here. You said you're going to be recruiting more activity, which is great. And I think that speaks to the strength of your pipeline and so forth. Any issues that you see out there in recruiting? Because I know bonuses were a little bit tight towards the end of last year. Has that translated or weakened your position at all on the campuses - on India - in India?

No, we're not seeing that. And, in fact, you know, the mostly recruiting that we need to do because we do have several hundred campus recruits coming on in the next few months. So, most of the recruiting we're - and those folks were recruited last year. Most of what we are focusing on right now is both senior and lateral recruiting. And we're having good success there because we seem to be recovering somewhat faster than our competitors. And there are a lot of good people available on the market right now.

Is the market as loose in India right now, in terms of labor, as it is in the U.S., where you can pretty much hire who you want, when you want to hire them? Or is it a little bit tighter over there, considering the demand for application management and so forth is still pretty strong?

You know, it's, I think, it's always tough to get good people and we're very selective. But it seems to be a little easier today than it was, you know, a year-and-a-half ago.

OK.

And, I think, one of the other things that changed is, certainly, Cognizant's profile. And the recognition that we are doing pretty well in the marketplace has helped us, as well.

Great. Thanks, guys. Nice job.

Thanks, Adam.

Your next question comes from .

It's actually . Good morning and great job on the numbers.

Thank you.

A couple of questions. Can we get a better feel on your bid and proposal pipeline, specifically, some of the larger deals in application management? We are hearing that there are a couple of very large engagements in the pipeline. It could be as large as First Data - your second or third largest clients down the road. Do you have enough capacity to support, you know, such potential large deals? Number one, how quickly will these ramp up if - whenever you do win these guys? Can you talk a little bit about some of these ...

Yeah. I'd say, , a lot of the growth in the first quarter, which will continue - it was driven by three or four large clients, which, unfortunately, I can't name. But MetLife was one that we've announced. There was a large money center bank deal that's starting to ramp up. And another large telecommunications company.

And an insurance company.

And an insurance company, as well. And there are several more that are just beginning to ramp up in the second quarter. And all of these, again, you know, we are, generally, very conservative about this stuff. But if we are to believe the plans that these clients are telling us, then, yes. There will be an aggressive ramp in the second half. But we, certainly, are pretty comfortable and that's one of the reasons we are - we are going out recruiting very aggressively for the sort of project manager, project lead types of levels. But we think we are pretty comfortable that we can meet the ramp ups this year and going into next year, as well.

Also, , remember, we're still running at reasonably low utilization offshore, compared to historic levels. So, as we get these significant ramp ups, both - you know, we can meet the need both through the lateral hire and we're doing as well is just bringing utilization back up to historic levels.

That's great. And then, looking at your application development business - I think it was up about nine percent on a sequential basis this quarter. I mean, which is - which is a pretty big number, especially for this group. Is that a consistent - is this - is this a - is this a growth rate that you think you can maintain throughout the year? I mean, maybe you can give us some more color on that. You did indicate that a big chunk of what's driving this is really existing clients. But are you seeing - are you seeing a demand up-tick coming in from new clients on board? Maybe you can give us a feel on your bid and proposal pipeline there as well.

Development revenue, including the reengineering, as I said - look at those together - increased about a million dollars a sequential basis. From what we're seeing, you know, we'll continue to see sequential growth - you know, modest growth, but continue to see sequential growth as the year goes on. As Kumar mentioned, you know, we are having success in cross-selling our application management customers and winning new development projects. What we're not seeing is the very large new development projects kickoff. But the - but the small ones - the somewhat non-discretionary development work. You know, we are having success there, especially within the existing customer base.

Yeah. I don't think - with the exception, I guess, of General Motors, which is a new development and integration kind. Most of the other work is, primarily cross selling existing clients. But, you know, sometimes relatively new clients, like MetLife, for example.

Great. And then, last question. Infosys was talking, on their conference call about the fact that they're in the process of building a practice that will focus on BPO. Any plans to, you know, that - any possibility that we'll Cognizant focusing on this, down the road, as part of your expansion strategy?

We are in active discussions, , with two or three different clients. We want to sort of do it on a client specific basis. And - rather than go out and invest a bunch of money in a venture. But it is possible that we'll have something to announce in the next couple of quarters. But, for the moment, it's up in the air.

Thanks, a lot. Good number.

Thank you.

Thanks, .

You're next question comes from .

Good morning. from Legg Mason.

Hi, .

How are you guys doing?

Good.

Congratulations, again, on a great quarter. I just want to hit a couple things. One, not to belabor this tax issue too much. But, Gordon, I just wanted to confirm that, you know, there should not be any cash consequences or per tax liability issues, just given the tax change at this point, unless you or do something else. Right?

That is 100 percent correct.

OK. Second, is, I guess, could you talk a little bit more about your ability to use the India generated cash for investments outside of the India and U.S.?

Just in terms of our ability - yes. We do have the ability, on a pretax basis, to use cash generated in India for acquisitions and investments anywhere outside the United States. And as Kumar discussed earlier, you know, there's a range of stuff we're looking at from acquisitions to expanding things like. And, you know, you'll probably see a range of activities.

OK. Are you limited in any - in any way - by any amount, for example?

The amount - the limits on amounts won't impact us. They're behind that level. It's not an issue for us.

OK. And I noticed that IMS revenue had a pretty substantial decline sequentially. Can you talk more about expectations there?

The - you know, in the past, I think, we've set expectations of about $5 million a quarter. I think that's a reasonable expectation. It's always, you know, it's always come down to around a couple hundred thousand one way or the other. But roughly five million a quarter. The only caveat with that - as you may have seen, we recently announced that we're working together on an offering to the pharmaceutical industry. If that - and it looks like we may have some success there. If that takes off, some of that may be on a subcontracting basis. But, if so, we'll be very clear on what's worked behind that versus what's subcontracting of work for pharmaceutical companies. But the core step behind that should stay around five million a quarter.

OK. And the - that alliance is one of the two that you'd exclude from the 10-K.

And we put it - yes. And also, we put a press release out a couple weeks ago.

OK. OK. And regarding the other one that you mentioned - an with - I believe, had already started to, you know, deliver pretty substantial results. Can you comment any further about how that ...

Well, yeah. The relationship is something we've had for a couple of years.

OK.

You know, which - it actually has been sort of the core of our health care practice. Today, we have the largest implementer of core claims processing systems bar none, including the big five in health care plans. And the reason that that happened, really, was we partnered with , which used to be, you know, part of IMS. It isn't anymore. And has now - which is now part of has become the leading claims processing platform by far, in that industry. So, that's helped us establish our position in the industry, as well. It's given us a lot of domain knowledge.

OK. OK. And, Gordon, can you talk about - I know you mentioned about 40 million for the - for the entire build out. What should we think about that translating into cap ex in '02 and '03?

Sure. In '02, related to the build out of the building, it'll be somewhere between 15 and 20 million - probably about eight - 17 million related to construction. And '03 it'll be - it'll be about 10 to 15 million - probably about - probably about 13, 14. So, the prior guidance we gave for cap ex this year was about 22 million. That includes 17 million for construction.

OK. And I wondered if you could talk a little bit further about your international strategy, in terms of - I mean, you've been talking about Europe for a little while now and I think that makes a lot of sense. But now you're also expanding in Asia and Australia. Can you talk a little bit more about that? Maybe where the offshore adoption is in those locations?

Yeah. I think - let me describe that in a couple of different pieces. Australia is - as we grow with some of our U.S. clients, some of the hot spots that they want us to be in, from a delivery perspective - clearly Europe, Southeast Asia, Australia, Japan. So, just from the perspective of serving existing clients, we are establishing presence in those markets. We also see - you know, we particularly see the next markets to take off, really, as being in Europe. The UK is already a fairly reasonably strong market. But northern Europe, also, we see as taking off - sort of following the U.S. model with a lag over a year or a year-and-a-half.

So, we want to be very proactive in those markets, but we will have presence - basically, Southeast Asia, Australia, Japan, as well in Asia. Those won't be, sort of, proactive pushes for - at least for this year.

And what kind of lag do you see with those areas, relative to the U.S. or to Europe?

A lot of the clients we're seeing in those areas do tend to be U.S. clients. So we haven't seen a lot of, you know, an option by local clients, if you like. And I'm not sure I have a good answer for you as to when that'll happen.

OK. OK. And, I guess, maybe the last question - thinking forward a little bit - just - based on expectations that you're talking about for '02. You know, if you assume that the application outsourcing environment that you're looking at now continues to be healthy and that, you know, just application development. Great line up - continues to show modest improvement. You know, what kind of longer-term growth, I guess, into '03, you know, would you think is reasonable to think about?

I think, you know, we had seven percent sequential growth this quarter and I think, you know, again we'd - that - I don't think we've built that into the guidance in the second half of our year. But there's no reason that should not continue even on a higher rate of sequential growth. If we are to believe, as I said, some of the projections. So, again, this is not guidance, but a long-term sort of growth rate trend. I don't see why seven to 10 percent for the sequential growth rate shouldn't be reasonable.

OK. Great. Thank you, very much and congratulations, again.

Your next question comes from .

Hi, guys. Good morning. Great results.

Hi, .

Most every question in the world's been answered - or asked by now, but just one quick one here, more qualitatively. Do you feel, right now, Cognizant, from what you've seen versus the competitors in the strong business apps management today, do you have any kind of competitive advantage in terms of ramp up methodologies, your ability to kind of bring the business on-line faster than, potentially, some of the other competitors who have hunting licenses out there or when you're bidding for hunting licenses?

Yes. I think, , you put your finger on one of the things we do - I think, do better than some of the competitors. We have focused very hard on really delivering bottom line cost savings to clients. Which, in the end, really does not depend so much on hourly rates, but it depends on transferring knowledge fast. It depends on moving work offshore fast. It depends on change management within the client, so that clients' personnel are appropriately re-deployed quickly.

So, it's much more than just a technical component of doing - of doing the work. It's a whole governance process and a change management process, which we think we've mastered with some of our large clients. And which - and that's the message that seems to be resonating well with clients who see us not just as a technology shop - though we are extremely good at technology. But as someone who can actually deliver the bottom line results to them. And, yes. That's helped us both in the ramp ups phases and also in winning new deals.

And how do you convey that in a pitch? If you're in - competing for a piece of apps management business, how can you convey, during the pitch process, with the client - this capability to maybe ramp faster and more, I guess, in a safer and more conservative way than maybe some of the competitors can?

I'm not sure I want to give away all my competitive secrets. But we do have, you know, fairly good intellectual property in all those areas. Plus we have people - you know, as you know, Cognizant is focused purely on business applications as opposed to some of the competitors who were really more R&D focused, I would say. And the thinking of the organization reflects that. So, I think, when people deal with that - deal with us - they see us as understanding the business issues and being able to deliver against the business issues. And the people we have on the front lines and the have, I think, reflects that. I can't - I'm not sure I can point to any one particular formula.

OK. Fair enough. And then, on the number - or the change in customers during the quarter - did we lose any applications management only customers in the quarter, in the net change in overall customers? And were all the new customers apps management customers?

Six of the seven new customers were apps management and, if I recall, sort of, were strategic deals. One was just a small development project. Of the ones - of the ones that we lost, they were - none of them were - none of them were huge, by any stretch of the imagination. Together, they generated less than a half million dollars of revenue in the - in the third or fourth quarter of last year. So, it was ones where we did a little bit of work and they decided not to continue with offshore for one reason or the other. But it was, once again, all small stuff.

Yeah. I think, you know, this is sort of continuing the trend that's been going over the last year or so, where, you know, we picked up a lot of smaller clients in 2000, particularly, and during the e-business boom, who really, you know, we probably should not have. We have been very focused over the last year on just very large clients with very large potential. So, we want to generate a lot of and so on and we're being pretty successful at it. So, I think, the quality of the client base has improved dramatically in the last year.

Fair enough. And then one quick question. How does the sun setting of the tax holiday in India affect the way you came up with the new effective tax rate here?

As you know, the sun setting on the tax holiday doesn't kick in - really doesn't impact us in a meaningful way until 2007, 2008. And then the tax holiday goes away entirely in 2010. So, assuming that the legislation doesn't change, starting in 2007 or 2008, you would start to see the tax rate come back up. And, by 2010, 2011, it would be fully back up. But, you know, certainly for, you know, between now and 2007 or so, you know, it really shouldn't have an impact.

And finally, the U.S. tax law only kicks in if you repatriate the cash into the U.S. Say, you buy something in Europe with cash, you don't have to pay more U.S. tax.

No, that's that the heart of - that's the heart of the strategy of why we took the tax rate down.

Great. Thanks a lot. Great results, guys.

Thank you. I guess, we have, probably, time for one more question.

Thank you. Your last question comes from .

Gentlemen, congratulations. Great quarter.

Thank you, .

Quick question. On the development and integration side of the business, what was the year over year and quarter over quarter growth profile, just as a percentage?

Sure. On year over year, apps management grew 21 percent. Apps development declined six percent. On a sequential basis - apps development was up by a million dollars. Call that about five percent. And apps maintenance was up by about $2 million. Call that - or a little over $2 million. So, call that about 10 percent.

And are you seeing a stabilization, did you say, in the development and integration work with a possibility of a nice upturn in the second half? Is that what you indicated?

Clearly, a stabilization. Even if we only had the $200 million of revenue for this year. On a sequential basis, I think you'll see modest sequential growth in development. If we meaningfully beat the $200 million guidance, that - part of that would be if development kicks back in a more substantial way. But, you know, worse case, we think it'll grow, sequentially, at a modest level from here.

Terrific. Thank you, very much.

Good. And I just wanted to wrap up then. Thank everyone for joining us today and we look forward to getting back together with you on the next quarter.

Operator, you can close out the call now. Thank you.

At this time, I would like to thank everyone for participating in today's conference call. You may now all disconnect.