高知特 (CTSH) 2002 Q3 法說會逐字稿

Good morning my name is April and I will be your conference facilitator today. At this time I would like welcome everyone to Cognizant Technology third quarter earnings 2002 conference call.

All lines have placed on mute to prevent any background noise. After the speakers remarks there will be a questions and answers period. If you would like to ask a question during that time you may press star and the number one on your telephone keypad.

If you would like to withdraw your question please press star and then the number two thank you. I will now turn the call over to Stephanie Prince SD of Morgan Walk.

Thank you operator and good morning everyone. By now you should have received a copy of the company's third quarter earnings release.

If you haven't please call FD Morgan Walk at 212 850 5664. On the call today we have Kumar Mahadeva, Chairman and CEO, and Gordon Coburn, Chief Financial Officer of Cognizant Technology Solutions.

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 the risks and uncertainties as described in the company's earnings release, and other filings with the SEC.

I would now like to turn the call over to Kumar. Please go ahead now.

Thank you and good morning everyone. Thank you for joining us.

The third quarter was another strong quarter for Cognizant, marked by double-digit year over year and sequential revenue growth. We finished the quarter with $61.2 million in sales, up 13 percent from the second quarter and 35 percent over last years second quarter.

Net income for the third quarter increased to $9.7 million or 45 cents per diluted share, from $6.1 million or 30 cents per diluted share in the third quarter of 2001, and 3 cents ahead of analysts circumstances estimate.

Revenue for the third quarter once again came in significantly ahead of Wall Street expectations, and continues to reach historic highs. The of several large deals continues to drive our growth, as the offshore trend continues to gain strong positive momentum. We believe this is a trend that will continue as companies continue to realize the competitive benefits of offshore outsourcing.

For the third quarter Application Management Services represented 58 percent of revenues. And Application Development and Integration accounted for 42 percent of revenues. Although Application Management is still growing somewhat faster than Development and Integration, we have now seen good growth in Development and Integration for three-quarters and believe that this is a trend that will continue.

Most of Development and Integration work is from existing clients, as we continue to have a high success rate in cross-selling these services to our Application Development clients.

Continuing our record of robust repeat business, we ended the quarter with approximately 88 percent of our revenues coming from clients who have been working with Cognizant for at least a year.

Cognizant has established itself as an offshore outsourcing leader in a relatively short time by building a unique fourth generation business model. The offshore outsourcing business has now gone through several generations.

In the early 1980's the first generation was characterized by starting companies that recruited staff in various offshore locations for onsite assignment in the U.S. and Europe. There was little cost or value advantage with this model.

The second generation was characterized by the few offshore companies who executed projects entirely offshore based on functional specifications provided by the client. While this model provided a cost advantage, it had several disadvantages. Only certain types of very well defined projects were amenable to this type of work sourcing, and a lack of communication resulted in quality issues.

Cognizant was a pioneer in the next generation, the onsite offshore model in which about 30 percent of the product team is onsite with the client, and 30 percent of the team is offshore. The rapidly declining cost of communications made it possible to tightly couple the onsite and offshore teams, and the client.

During the 1990's Cognizant and a couple of others a third generation model to a point at which it delivers high quality and speed at low cost, across a wide range of service offerings.

Cognizant has now taken the lead in defining the fourth generation. The fourth generation offshore provider is focused not just on technology, but on delivering business results. The fourth Generation Company will be focused exclusively on business applications, and be organized by .

The fourth generation will seek to establish a close client partnership to extend and leverage client capabilities and will not be contract driven or driven by discreet projects.

Cognizant's fourth generation model is also characterized by a business model in which executive management head quartered in the U. S. and Europe are in close proximity to clients and senior client partners work as consultants to clients and are empowered to make strategic decisions directly with these clients.

Cognizant's model also benefits from a unique business culture, which is neither India centric nor U. S. centric. While the company is firmly routed as a software leader in India the majority of our managers have extensive multi national experience and Cognizant runs programs to minimize the cultural divide with clients.

Clients comment on our people centric can do culture and our responsiveness and speed of decision-making. In designing the fourth generation Cognizant has also enhanced it's service offerings to deliver bottom line business benefits.

For example we have introduced change management and program management services to manage large scale out sourcing programs and achieve high off shore ratios.

And a transformation outsourcing service combining management with consolidation and transformation of the clients IT organization and applications port folio creating saving and performance improvements well beyond what is possible with traditional ex management.

We've also enhanced in development integration services as a high performance user friendly alternative to the big five. Cognizant has built strong business and technology architecture capabilities and structured with industrialized E business applications. The high performance in real world situations.

We have also built industry leading legacy portfolio rationalization and transformation services and we are seeing much demand in this area. Finally our industry practices now have now matured to the point where we can bring strong industry expertise to the table.

That combined with clients specific knowledge gained over time through applications management work this is an unbeatable combination. In the third quarter financial services was our largest accounting for 35 percent of revenues compared to 30 percent in the second quarter.

Our staff's experience and knowledge of the specialized needs of this sector have been crucial to the growth of this important client base. In the quarter we announced the potential acquisition of Silver Lines operations associated with there servicing of American Express.

This is still pending but is an indication of the lengths we will go to service our clients. The health care medical accounted for 24 percent of revenues this quarter as we maintain our strong position in the pair industry. An increased double in the pharmaceutical sector.

In the third quarter Cognizant was accessed by KPMG at people CMM level five which means that we have best in class practices to attract, develop, motivate, organize and retain talent across all our development centers in India.

This is probably one of the reasons we are the top recruiters in MBAs and one of the leading recruiters of engineers in India. BCML level five also means that Cognizant can continuously strengthen its competitive edge.

By continuously improving the capability of the organization and increasing the capability of it's work force to handle more and more sophisticated technology projects.

Due to the visibility of our business we are once again able to raise guidance. We now expect to record approximately 64 million of revenue and approximately 46 cents EPS in the fourth quarter.

For the full year we are raising our guidance to 260 million in revenues and approximately a dollar 67 EPS up from a dollar 59. This guidance does not include the acquisition of Silver Lines American Express business.

Looking out to 2003 we anticipate that the economic trends and main stream acceptance of off shore out that for all there recent growth will remain in place. They are currently in the process of discussing plans for 2003 with their clients and we are therefore not ready to for 2003. But suffice to say that it is likely to be higher than Wall Street estimates and with that I'd like to turn you over to Gordon.

Thank you Kumar and good morning to everyone. I'd like to provide some additional information on the third quarter and then discuss our financial expectations for Q4 and beyond in more detail. Revenue for the third quarter far exceeds our expectations. All of our core businesses remain solid and performed well. We experienced growth in our key verticals.

Our pipeline is robust. And we are confident in our ability to continue to deliver healthy sequential revenue growth during the remainder of this year. Both applications - management and application development grew sequentially in Q3. During the quarter application management grew 14 percent sequentially and 47 percent year over year. Application development and reengineering grew 10 percent sequentially and 20 percent year over year. We continue to penetrate to our vertical markets our two largest segments financial services and health care grew 30 percent and 11 percent respectively on a sequential basis.

Retail, manufacturing, and logistics increased to 20 percent of revenue and information services remained at 14 percent of sales. The remainder of our revenues came primarily from other service-orientated industries as well as our alliances. We added six new customers during the third quarter including a major financial institution, a major health care organization and a large retailer. Our active customer base remained at approximately 105. Four of we won in the quarter have the potential to become significant revenue sources for us in the future.

Turning to costs. Costs of revenues increased 43 percent for the quarter as compared to the third quarter of 2001. The increase is almost entirely due to additional technical staff both on site and off shore required to support our revenue growth. We increased our technical staff by 1200 people compared to the third quarter of 2001 and ended the quarter with 4700 technical staff.

This is a net increase of 875 staff from June 30th of this year. Approximately half of this increase was that will go through six months of training with us. In addition during the third quarter the percentage of work delivered on site increased slightly on a sequential basis due to short term knowledge transfer activities associated with the rapid ramp up of several of our newer clients. We delivered approximately 31 percent of our services on site in Q3 compared to 30 percent in the second quarter of this year and 27 percent in the fourth quarter of last year.

The higher salary cost associated with on site personnel contributed in part two sequential increase in cost of revenues. We expect the percentage of work performed on site during the fourth quarter to decrease slightly as we transitioned from the knowledge transfer phase to on going support for several of our major clients. Finally and most importantly due to the significant increase in our expected financial performance for the year we continue to increase our employee bonus expectations to a level well in excess of 100 percent a target.

This increase and anticipated bonus pay out versus target negatively impacted gross margin during the quarter. Gross margin was 46.2 percent. A decrease of 300 basis points compared with our gross margins in the third quarter of 2001. Any 20 basis points increase compared to the second quarter of this year. The primary driver of the reduced gross margin was the increased bonus accrual, which I mentioned earlier, partially offset by improved utilization. bonus at 100 percent of target during the quarter, gross margin would have been 175 basis points higher.

SG&A expenses including depreciation was 16.2 million, up from 13.1 in the third quarter of last year. As a percentage of revenues SG&A was 26.4 percent for the third quarter, a decline of 230 basis points from the third quarter of 2001, resulting from our ability to leverage last years sales and marketing investment, as well as continued cost control actions.

Operating income for the quarter increased 30 percent to $12.1 million and our operating margin was 19.8 percent, down approximately 70 basis points from the third quarter of 2001, and up 10 basis points from the second quarter of this year. We were able to maintain our operating margin despite the increase in our bonus accrual due to our ability to leverage our sales and marketing investment, which we've made over prior quarters.

Interest income for the third quarter is 471,000 compared to 643,000 for the third quarter of 2001. Interest income declined despite significantly higher cash balances due to the drop in short term interest rates. We had a $24,000 gain during the quarter due to the strengthening of the British Pound and the stability of the Indian Rupee.

Our tax rate was 23.4 percent for the quarter, consistent with our prior guidance and our expected full year rate.

Turning to the balance sheet, we finished the third quarter with $123 million of cash an increase of $19.2 million for the quarter and 38.1 million-year to date.

During the third quarter operating activities generated 15.1 million of cash. Financing activities specifically the exercise of stock options generate an additional seven million of cash. These amounts were partially offset by $2.7 million of capital expenditures, including expenditures on our Indian 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 , is 135,000 square feet and will house close to 1,000 programmers.

Next month we expect to open the second of our three . The second facility, located in Calcutta, will be 115,000 square feet and will house close to 1,000 programmers.

The third , located in , will contain 370,000 square feet and will house close to 4,000 programmers. The first phase of this facility will come online in the spring of 2003. We recently accelerated the construction schedule for the facility, and now expect the final phase of that facility to be completed in the fall of 2003.

For full year 2002, we expect to spend approximately $20 million on total capital expenditures.

Our collection of trade receivables during the quarter was very strong. Based on our $39.4 million balance on September 30th, we finished the quarter with a including unbilled receivables of 59 days, below our targeted of 70 days. Excluding unbilled receivables, our was 48 days.

Overall our balance grew by only $1.2 million during the quarter. The quality of our receivable portfolio remains exceptionally strong. Of our total balance less than 3 percent is over 90 days.

Our unbilled receivable balance increased during the quarter by $500,000 to 7.5 million. This increase resulted from the company's continued effort to ship work towards fixed-bid contracts. During the third quarter 27 percent of revenue was from fixed-bid contracts, with revenue from fixed-bid contracts increasing by 2.9 million from the second quarter of this year. Our fixed-bid contracts generally have quarterly billing milestones. Turning to head count at the end of the quarter our worldwide head count including both technical professionals and support staff total approximately 5200.

This represents a net increase of approximately 950 people during the quarter. Approximately one half of the bill quartered editions were lateral higher of experienced IT professionals.

Annualized turnover was 13 percent during the third quarter including both voluntary and involuntary. Voluntary turnover was approximately nine percent annualized and involuntary turnover was approximately four percent.

Utilization during the third quarter was approximately 91 percent on side and 73 percent off shore excluding recent college graduates who are in our training program.

Including the trainee's off shore utilization was approximately 62 percent. During the third quarter we accelerated our higher trends in India in response to the strong demand we are seeing for application out sourcing.

Based on current hiring plans we expect to finish the year with well over 5500 employees worldwide. I'd now like to comment a little bit more on our growth expectations for the fourth quarter and beyond.

As Kumar mentioned we're comfortable with our ability to deliver revenue in the fourth quarter of approximately $64 million. We continue to have significant revenue visibility due to our high level of recurring revenue and long term nature of our customer relationships.

In fact today we have customer commitments for well over 95 percent of our fourth quarter revenue guidance. During the fourth quarter we expect our sequential volume growth to exceed revenue growth as a percentage, as the percentage worked delivered off shore increases.

As I mentioned earlier during the fourth quarter we expect a shift from on site to off shore of the accounts where we've completed knowledge transfer. Our fourth quarter guidance excludes any financial benefit from the Silver Line acquisition which we hope to close this quarter.

During the fourth quarter we intend to continue to closely monitor our spending and expect our operating margin in the range of 19 to 20 percent more likely at the high end of that range in line with our historic margin and prior guidance.

With it's expected level revenue growth and expected operating margins we're currently comfortable with our ability to deliver EPS of approximately 46 cents. As Kumar mentioned earlier we are currently in the midst of the 2003 planning process with our clients.

Based on the initial feedback from this process we are quite optimistic about the outlook for next year. Now Kumar and I would like to open the call for questions. Operator.

At this time I would like to remind everyone if you would like to ask a question please press star then the number one on your telephone key pad. We'll pause for just a moment to compile the Q&A roster.

The first question comes from Andrew from Bear Stearn.

Congratulations on the quarter.

Thanks.

: Could you just talk about a little bit sort of outside of yourselves just a more general off shore platform I mean that's what it seems like we're going through a sort of a second wave of adopters you know sort of how long do you think this sort of second wave of sort of new interest into the pipe line will last? For not just you but you know sort of all the leadership off shore players.

Yes Andrew this is Kumar Mahadeva I think what we're seeing is that off shore is really on the verge of going main stream if you like. Up to this point the primary users that really leading edge companies pushing the model people like GEE and American Express who, who get large volumes of off shore out sourcing.

By in large most other organizations were sort of dabbling. We see that significant change in that this year but we think think it's extremely early on the adoption curve so you know if you like we are crossing the chasm at this point but it is still to enter the real growth phase that we expect to see over several years going forward which is one of the reasons we are adopting this fourth generation model I talked about because as the market does go main stream it's extremely important that it be user friendly and easy to access as more and more users are not willing to put in sort of the effort that a general in the early stages to set something like this up. So our view is via sort of past the embryonic phase just entering the growth phase.

Gordon could you just give us off site off shore and just give us a feeling for sort of going forward we think that will remain steady for Cognizant and sort of more general off shore community.

Sure Andrew. remain very constant with what we saw in the first half of this year. We averaged about $24 an hour off shore and between 69 and $70 an hour on site going forward based on what we're seeing right now looks like should continue to remain quite stable.

: Yeah. Thanks for all the comments. I appreciate it.

Thanks Andrew.

The next question comes from Goldman Sachs.

Good morning guys. How you doing? Real quickly. Just to I think you said that the silver line acquisition you expected to close in the third quarter. Is that correct?

We're currently working on the deal and we would certainly hope that it would close in the current quarter.

: OK. And you haven't given any specific numbers yet around revenue or earnings secretion form the acquisition.

We've not given any numbers but any financial benefit from the acquisition are not part of the guidance we just gave so anything would be an addition to our current guidance.

: What was the - what other detail did you provide I mean it sounded like. I think the only thing we had was the number of employees that you guys were going to something like 300 employees.

That's correct. That's the only information that's been provided at this point is the general size of the employee base that we take over is roughly 300.

: OK. And in terms of customers the key customers there being obviously American express.

That would be the only customer ...

That would be the only customer.

: That's the only customer.

It's actually all divisions of .

: All of the divisions of .

Yeah.

: How would that work there when - I think they just recently signed a pretty big agreement with IBM. Would you guys be doing sort of sub contractor work there or how is the work different if you guys have on that?

it would be appropriate for us to get in to a whole lot of details right now. Certainly if - when the acquisition closes we'll provide more detail.

: OK. I guess then the only other question that I had was regarding expectations for just for the - for cap ex for the rest of the year. Would you mind going through that and just give me the DNA numbers as well for the quarter.

Sure. Cap ex this year as we discussed in call is very back end loaded because of final payments on the Calcutta facility that's coming on line. At this point we still anticipating spending roughly $20 million on cap ex for the full year. To date we've spent about - around a little bit - about eight million so we've probably spent somewhere between 10 and 12 million in the fourth quarter. A lot of that has to do with final payments on construction. Depreciation for the quarter was about $2 million. Given the growth continued to increase modestly. You'll get a little bit of a bump when the new facility comes on line but not massive.

: And then if you wouldn't mind just repeating the percent onsite versus percent offshore in your employee mix.

Sure. Of consultants we're with 31 percent onsite in Q3.

: OK. And just finally, the utilization onsite versus offshore?

We were - utilization onsite was 91 percent, and utilization offshore - just give me one second - was in the low - was in the - was 73 percent, excluding all the trainees we just hired. If you included the trainees training in our training program for six months, it would be 62 percent. But the 73 percents really a more meaningful number.

: Sixty-two percent?

Including the trainees.

: Got it.

Now there's a lot of seasonally there, there are a very large number of trainees that came on in the third quarter.

Your next question comes from from .

Can you hear me well?

Yes.

.

Hi .

Hi .

: Great. A couple of questions. Can you talk about margin trends, looking both at gross and operating margins as it relates to your maybe mix of business, application maintenance versus application development? Does that - how does it impact those trends? That's number one.

And then can you also talk about - you mentioned earnings visibility into Q4, is there any way to give us a feel on earnings visibility into at least the first quarter of 2003, at this point? And even beyond if we can.

And then I think we're missing two more metrics, which is your European revenues as a percent of total revenues, and then your top five clients, this is revenue concentration. Thanks.

Sure. just the first part of the question again, before visibility was - the first thing you asked?

: It was gross margin and operating margin trends as it relates to your mix of business.

Yes. Got it. Let me start with that.

The margins on the two sides of the business are relatively similar, but there are some underlying characteristics that are different there. Maintenance tends to be more offshore centric, developments more onsite centric. But rates are a little higher on development so it all washes out to similar margins.

We don't see any reasons why our operating margins next year would not be consistent with our operating margins this year. Gross margins, as you know always can bounce around a little bit from quarter to quarter depending on the onsite-offshore mix. What - how much transfers going on and so forth.

As we mentioned gross margin was negatively impacted a little bit by the fact that we're paying out such big bonuses. But you know, the more important metric, which is the operating margin, that we see being very steady. And gross margin's always bounce around a little bit as it doesn't pass. But yes, we certainly don't see any major changes.

In terms of visibility, obviously we have great visibility for fourth quarter. Given 58 percent of all our work is maintenance, and our development projects are fairly long we also have very healthy visibility into Q1 as well, so do not take our lack of giving a specific number for Q1 as any concerns of visibility. We remain quite optimistic about what we're seeing going into next year.

Yes. Let me just expand on that .

A pipeline is, both from existing clients, is as strong as we've ever seen it so you know, we are optimistic. The only reason as you know, the fourth quarter is the time when most clients are pinning down their budgets, the partnership model is such that we are sitting actively working on it with them.

But you know, the bottom line is that we are expecting a strong 2003. We don't see any reason that the recent trends you've seen should slow down.

And all the feedback we've been getting from clients so far has been good news not bad news. So we're - it's all looking quite good at this point.

: That's great. And then the two metrics, that's.

Sure. Top bar customers with 42 percent of revenue this quarter that's obviously up from last quarter.

39 percent of last quarter.

Right. All of the top five customers grew their revenue on sequential basis. You know there was one new customer that moved into the top five. So one of these bigger deals that's been wrapping up but the increase in expenditure of revenue comes from the top five was driven by, by growth add all five in the top customers, so yeah we continue to be quite pleased with that and we're also very pleased that so that the next group below that we have a bunch of customers who are ramping up and you know I think over time you all should see some changes and who are in the top five because some day more recently this old growth of be so large that they're display others in the top five category.

Europe.

Yes Sir, revenue would Europe a one second was 13 percent Europe one percent Asia, 86 percent North America so very consistent with what we saw in parts quarter.

And then I guess last question on Europe are you saying anything in terms of growth there are you beginning to see a better understanding of the all firm model more expectance on the road?

But we one of the things that we've been very quite successful at is extending the U.S. client relationships into Europe so we are seeing quite a bit of growth from U.S. clients we've had some time who found the model works very well for them to hear extending that model into Europe and frankly the rest of the world at this point you know clients like first aid bands, some of them financial institutions that we worked in.

In terms of domestic headquarters European pliancy the dare option is somewhat, somewhat behind the U.S. clients but you know we have made some break through there as well and we're targeting the European Market by so you know the Pharmaceutical market in Europe given us strength in that sector here and but for the moment a lot of the group - growth appears to be driven by the U.S. clients.

Very good, thank you.

OK.

You next question comes from Joseph from Jefferies and Company.

Hi Gentlemen and a great result as usual.

Thank you.

: Just a couple of questions on revenue growth here how do you play huge sequential increases in the absence maintenance business for two quarters now. If we looked at the bump up between Q2 and Q3 could you give us some color as to where that contribution was coming from, obviously the existing customers are growing but was could you kind of buff for us maybe were these Q1 or Q2 new customers contributing a lot of this growth or was it coming from the existing base?

A lot of the growth was coming from customers we won and the second half of 2001 cause those were the customers who are in the very significant growth directory now.

We also saw though some reasonable growth from some customers we've had one before that who - so it came back for doing additional maintenance work with us and I think part of that due to the conceded expectance of off shore and pressure on budgets.

But the biggest part of that is from clients we won from May to December of last year.

Yes it's just to put some color on that Joe. In typically in these large out sourcing deals you know you sign the hunting license if you like. It takes three to six months of pirate projects and knowledge transfer and various other activities before the ramp up tends to begin in earnest so you know your talking clients you want late last year early this year ramping up very aggressively at this point and you'll see other clients coming in, in later and the point that Gordon made also is very important.

Many earlier clients who have sort of being dabbling with off shore for a while have now gotten really serious and they have come back and said you know we believe the model is working very well. We want to ramp up aggressively because we think this is something, which works.

And Joe that's also one of the reasons why we are quite quite optimistic about what things are going to look like next year. Because in second quarter, third quarter of this year we want saying very large clients who, who are supplying to want to ramp up to be quite large.

The revenue impact from those clients has barely begun to show up in the numbers and when we will see the strength of revenue from the clients that we won you know last quarter and the quarter before that'll really only be next year so we have a nice tail win of stuff we're already won.

: Right that was the next logical question was the 11 customers you signed last quarter. Sounds like they're really weren't materially contributing to revenue versus some of these other ones that have been around for a little while longer.

They contribute a little bit but certainly not material. If you recall last quarter of the I think 12 clients we won we said six were what are called one second grow to be large clients and as I mentioned a few minutes ago of the clients we won in the fourth quarter, in the third quarter another four were considered one oh grow to be large so we have 10 clients that we've won in the last six months where the revenue that you've seen so far is negligible compared to what it will be.

And you know the definition of large in the industry is also changing significantly you know a year ago a five million client was large today its $10, $20 million or more. Typically when we talk about large.

: And then one question on the development side. If you could kind of quantify for us the growth here. I mean it could only come from one of three areas. It would come from customers A deciding to do work with you instead of doing it internally.

Customers deciding to do work with you versus maybe a domestic player so that would imply a share shift towards your business model or third adjust your business that you kind of dug up on your own and sold.

As a result of your own selling after can you kind of quantify where you think the growth might be coming from.

Well if you look at the application management, application out sourcing side of the business I guess most of that is stuff that clients have traditionally done in house and therefore I guess you could argue that it's in your first category that they are moving work that they would otherwise have done within there own organization.

I think that the development and integration work is by in large, which we do actively go dig up, and cross sell and go to clients proactively with ideas on what they could do.

I think would normally have been executed by in large outside of the organizations by external companies you know but not necessarily all of it.

: OK very good and then just quickly customer count stayed flat in the quarter could you comment on the drops and who they were, if they were any large customers that dropped off.

There were no large customers that dropped off. The customers that dropped off in just put it in perspective in Q2 of this year. The customers that dropped off in Q3 in Q2 they generated less than half a million dollars well under half a million dollars of revenue. So they were all relatively small customers.

Yeah but one of the things I should also comment you know as the - as our business grows and as the average size of our customer portfolio grows it becomes harder and harder for us to keep relationships that really don't want to. They tend to be less profitable when they are extremely small so you will see a little bit you know continuing process. One large client that - someone like a is equal to 10 or 20 small clients. So our business model is very much focused on getting those large plants and growing them so you will see a little bit of churn in that customer base going forward.

But I want you to none of them are large clients through all various .

: Was that the half a million for Q2 that dropped off in Q3.?

The clients I felt dropped off in Q3 in Q2 all of them together generate well under half a million dollars of revenue ...

: So you were saying ...

They're very small.

: Great. Great result.

Thank you.

The next question comes from from .

Good morning guys. Nice job on the quarter.

Thank you.

: You may have mentioned this but on the mix of net ads on off shore versus off site this quarter. If you could just give us those numbers Gordon and then on the related party revenue for Q3 now that was obviously up again sequentially. What kind of you know what should we be modeling now I guess in Q4 and as you kind of look out to 2003. Just thoughts there. Thanks.

Sure. as you know the majority of the hires that we do even core on site are people who come from off shore. So I think the way you want to think about it is the on site next increased slightly so we went from 30 percent to 31 percent on site. But most of the people who came onsite were from off shore. And I'm sorry the second half of the question.

: Yeah on the related party revenue you know that was up again sequentially it was ahead of my expectations. How should that look I guess in Q4 and as we look in the fiscal '03 any sense on visibility there?

Definitely that should relatively flat, I think it was up a couple of hundred thousand dollars. But I would model that as relatively flat.

: OK. And then if you can just provide an update on the BPO market. Any thoughts on in to that market and if you've done any kind of experimenting with clients. Any would be helpful there?

Yeah you know I think we announced last quarter that we had hired a President for that business. We are actively working with I think four clients at this point who want us to operation mostly in sort of the back office administrative areas for them and we should be kicking off those in the next couple of quarters however you know again - no do not expect any significant revenues yet and we have not modeled any other models any revenues at this point from so I think it's still at an experimental point.

: Right is there much investment dollars if you can go into that at this point or?

No. No it's very small and again everything's included in our guidance but we have not counted any revenues from .

OK. Thanks .

Our next question comes from from Janney Montgomery Scott.

Thank you. Hi Gordon. Hi Kumar. Just a few questions. Actually both of them are answered but could you talk a little bit more about the competitive landscape and how has that changed over the past 12 months say are some of the domestic providers now becoming more competitive? Are you seeing more activity from some of the second year off shore guys who might be posing a competitive threat. Just a little color on that would helpful thanks.

Sure I think if you're topping off sharply I think we've seen just the reverse that there's three or four companies that are winning the bunch of the deals and the second really seem to have this year fallen by the wayside and seem to be getting into considerable difficulty frankly in terms of financial performance.

And so there is probably, you know, four, five, six at this point who are winning a bulk of the deals, and I think will continue to grow a lot faster than the rest of the field And that's partly because the scale of these deals has gotten so large and the range of services that are required have gotten so extensive that it's hard for many of the second tier to compete.

As far as domestic go, we've certainly seen them more aggressive in recruiting in India, although they really don't - haven't posed much of a threat. I haven't seen any of the major U.S. who have offshore capabilities like and IBM win any of these significant deals yet. And I'm not sure exactly why that is, but so far they have not really had much of a market impact.

Would you describe the environment as the pie getting bigger, and Cognizant is taking market share from even the top-tier and that is why you're growing faster than your competition?

I'm not sure I'd say we've been growing faster, you know, I'm sure we have in the last couple of quarters, but over long-term I'm not sure we're necessarily growing faster than the top two or three players. I think that the top four or five, including Cognizant will all grow extremely fast over the next several years. I think what you see is the second tier will not grow as fast.

But you know, Cognizant's now clearly established itself in that pack, and is significantly differentiated from the rest with the fourth generation model that I talked about. So I think we'll continue to do well, but you know, we see many of the other top company's also doing very well.

OK. I guess one final question.

One of your competitors, I think it was Wipro, who announced that they were getting into the total outsourcing business which means also getting into the infrastructure part, which of course is much more capital intensive. I was wondering if you guys could comment on that. In terms of is Cognizant looking to maybe make inroads in that market as well, to take advantage of the offshore model?

Sure. The answer is yes, and no.

The yes part is we are getting into infrastructure management. So clients want us to, you know, much of what we do today involves consolidating application portfolios, consolidating infrastructures. So clients have asked us "hey if you're going to do that why don't you manage the infrastructure for us? Manage the servers, manage the networks".

However we do not intend to get into the business of owning the infrastructure. So it will not become capital intensive, so we will either have clients continue to own the infrastructure or partner with somebody to provide the infrastructure. But we don't wish to get into a capital-intensive business, so we will stay in the management business not in the ownership business.

OK. And I guess the final question is in terms of , would you consider any acquisitions in India that, you know, it seems like a lot of company's cropping up but we're focusing on specific market segments like finance and accounting and so on. Is that a strategy that you might consider to better create that market in a big way?

We have been looking at acquisitions, but most of what we have found are call center companies today. And that is very much of a commodity business at this point. We don't think that's where the money will be made in . We think it's in processes. And we have not found high quality properties focusing on the area of the market that we think will be profitable.

OK. So it's going to be more of an in-house kind of development?

I think so.

.

But certainly we are open to acquisitions if we find them.

OK. Well thanks guys, and congratulations. Great quarter.

Thank you.

Thanks .

Your next question comes from from .

Let me start with new clients. They fluctuated somewhat over the last several quarters, I was wondering if there's an internal quarterly target? and maybe if you can talk a little bit about what we can expect in Q4.

Sandy defiantly no internal target and it is fluctuated but the main thing we focus on is not the total member of new client wins but the number of what we call sort of the larger, larger strategic deals as a mention last quarter we won 12 clients, six of which we have put in the strategic category.

Past quarter we won six clients, four of which were in the strategic category. As Kumar mentioned earlier one large insurance company may be better off for us then 20 very small clients. So there's no number of clients per quarter we're much more focused on the quality of the clients.

As Kumar mentioned we're very pleased with the pipeline. Both the pipeline of clients set again close to - the pipeline right across the board. The clients who are currently ramping up, clients that we've just won very recently who haven't even started to ramp up including the four that we won last quarter.

Prospects who are in the very final stages of selecting their off shore partner and who will sign this quarter and we're also seeing very healthy activity at the top of the funnel. New prospects who are just kicking off the process so we think our pipeline is staged out as well as it could be.

: OK. And in terms of a new hires this quarter well above plan. What's the lab time before the new employees excluding campus hires would be deployed on projects?

Sure as you know campus hires there's about six month life time, lateral hires you know they get deployed within a matter of weeks.

: OK. Next question is much more of a mackro question who was at a conference recently and is there talking about the impact China could have on the off shore IT Services Industry.

Just wanted to get your comments on how you see that playing out?

You know we agree. I think that China is properly the next step significant pool of resources after India. We think that it's going to be some time before China can effectively build a scale and the capability that India has. But we actively looking at China as our next location and we start to experiment with it pretty soon.

But you know in terms of being CDs competition doing I think its four or five years out.

: And do you think that the model in China will start right off at the fourth generation that you talked about or do you think it might start off at the third generation and move up.

I think we properly start off more like trying to establish the technical delivery capabilities in China I mean obviously there are more language issues and other issues with so we may start off doing if you like slightly lower and work there then we're delivering out of India but with the intention of scaling up pretty fast.

: OK. And my last question has to do with the existing consumer revenue growth. I believe this quarter was up 10 percent sequentially and I just want to be clear on where this growth is coming from.

Is it coming from expansion of application management contracts, application development or other services such as upgrading package application or package dapt software?

I think it's really all of the above and the reality is that with many of our clients we're still our is miniscule even if we do you know $20 or $25 million a year with which is sort of a run rate that's still a very small part of maintenance budget and as they find the model working they tend to do more and more and it does fall into more application management contracts.

We go in and actively cross sell ideas for development reengineering work and recently we've been seeing quite a bit of attraction in packages particularly upgrades some CIN work and application maintenance of packages.

: OK thank you great quarter.

.

Your next question comes from Brian from .

Yeah hi gentlemen just most of my questions have been answered. I just want to ask you first of all how much work if any have you done with American Express before this acquisition?

We actually have none done any work with them. They preferred off shore went there a couple of months ago. And so this is suddenly this is a way of getting with them. the program and something that they were obviously very supportive of.

: Do you expect this to be one of your so called larger clients or even top five and if so do you expect it to have some more margins than most of your other projects that you know are going on?

Certainly when the Silver Line deal closes American Express will be one of our larger clients. You know at this point I don't want to comment on margins just cause we're in the middle of the deal.

: OK great thanks guys.

Your next question comes from from Capital Market.

Hi a great quarter. Just a clarification I know you talked about fixed price contracts and how that had grown in the percentage of total. Could you just clarify some in an accounting perspective obviously there's a lot of concern about accounting for services contracts right now in terms of how you account for that and when and if there's any true up and when that happens?

Sure. Let me both walk through the accounting but let me actually answer the second part of your question first. We've never had any significant true ups on our fixed bid contracts and a big part of the reason why is we're not betting on the mats of productivity against the make the fixed bid accounting work because of the proposition of the off shore model.

We can generate real cash savings within a matter of weeks after starting a contract and we don't have big up front investments so we don't have we didn't just simply don't have the issues that some of the domestic players have.

In terms of how we recognize revenue. We recognize revenue based on percentage of costs incurred so we'd look at the total cost that we expect to incur to deliver the contract.

What percentage of it have we incurred to date and that's the percentage of revenue that we recognize and the true ups and true downs tend to be nominal.

: Right and then on I guess a next question in terms of the rest of your contracts are all materials is that correct? You say about 31 percent is fixed price.

About 27 percent is fixed price and the remainder is materials.

: OK and then in terms of you know on the competitive side so that and IDM your still not really seeing in terms of a from a competitive stand point. I mean are they just in the early stage of the competitive process and they get knocked out I mean that's a that you had said in prior quarters is there kind of really no change with those guys?

We've been seeing IDM in the early changes and they may tend to get knocked out. we're really not seen at all in sort of the final rounds of competition. My suspicion is that they use off shore behind as a resource behind some of the products there're doing for clients but don't bid if you like the pure play off shore deals which is where we play.

: OK and then the final point is are you seeing any life in software companies starting to move some of their developments more to off shore providers is that a trend that your starting to see? We've talked to some companies where they are doing a component of their development with off shore companies. Is that an area your really targeting or you know can you give some color on that?

Yeah I think we've seen some of it. It's not our primary target it's to us it's sort of a means to an end so you know for example we focus on the health care medical market so if there's a major provider of software to the health care industry who wants to out source development to India and is also interested in partnering us - with us for their clients. Then we would be very interested. But in general, we do not want to be in the product development business. We are interested in the IT services, applications business, so that's where our focus will be.

So the work we do for product is where they fall into one of our .

: Right. Thank you very much.

Thanks Sandy. Operator I think we have time for one more call.

OK. Your next question comes from from .

Good morning, from . Again my congratulations on a great quarter.

Thank you.

Thanks George.

: If I could slip in under the wire here. A couple of follow-ups, a lot of my questions have been answered.

But first just to be clear Kumar on the - you know, your optimism on 2003, that does not factor anticipate ?

No. Exactly. They - we have not in any comments we have made today not included potential benefit from that inclusion, which would be incremental.

: OK. Can you - I mean, you know, it sounds like the anticipation is this quarter, but can you handicap this at all? Give us any sort of likelihood or probability that this deal goes through?

I think it's quite likely. You know, as you know there are a lot of issues going on at so there are some things that we have had to work through, but at this point it's looking much more likely than not that it will close. But again, you know, won't know for sure for a couple of weeks.

: OK. And you know, hiring has been strong. It sounds like you're taking advantage of one, the obvious labor pool in India, and probably cherry picking to some extent from your - from tier two and tier three firms.

But you know, are there any issues with the strong hiring? I guess you know, are you - do you feel you're able to manage that kind of influx? Is there any you know, wage pressure issues? Any you know, quality issues that you're seeing with this kind of hiring?

Not so far. I mean we have - even when we were a much smaller company, you know, being effective at adding well over 1,000 people a year and you know, that rates increasing now. But our capability to add and scale has increased substantially also. You know, the offshore business is strong and I think the top four or five players are all recruiting aggressively, but as you say there are a lot of smaller companies that are not doing so well, so that's a source of talent.

At the lower levels there's really not an issue of cognizance, position is extremely strong and you know, we get preferred employee status in most of our recruiting. There is a little bit of a bottle neck at the more senior levels, the middle to more senior levels, where just a very rapid growth of the industry has created a bit of a bottle neck.

But there we actually have something of an advantage over our competitors because of our very strong recruiting structure here in the U.S.. And so one of the things we are doing is recruiting more of those front-end people, program managers, architects, etceteras, in the U.S.. Sometimes people who are here from India, but who are located here in the U.S.. And that fits into our model where we do have more of those front-end people located here rather than in India like some of our other competitors.

So you know, long answer to a question saying so far we have been not having any significant issues.

: OK. And just as a follow up to that are you - you know, I recall earlier this year that you had made some hiring into some of your verticals and some of your kind of horizontals at, you know, mid and mid-senior levels getting some people in the States from some of the domestic companies.

You know, are you - is that continuing? Are you seeing that you're able to get, you know, that kind of experience from, you know, from some of the domestics who are having, you know, demand issues.

Absolutely I mean we're just flooded with resumes and requests from the big five and up all the domestic players and we sort of have the pick there in terms of recruiting people AO we are taking advantage opportunities so they will gracefully recruit practice leaders, , program managers. All of the senior staff back that. That I think will be the crucial bottle deck if you like that we have to over come to banish the you know sort of high growth we're expecting next year.

: OK. Gordon. A couple of housekeeping items former clients. Can you give that percentage?

Certainly. All of the former clients including health represent 22 percent of revenue. 78 percent of revenue came from clients who had never been affiliated with us.

: That's - as I recall that's up from last quarter Yes?

Last quarter it was 24 and 76.

: OK. And then I missed the cash from operations and cap ex for the quarter.

Sure. Hold one second. For the quarter cash from operations was 15 mil. Cap ex was 2.7 mil. And finance activities exercise was and stock purchase program generates 7 million of cash.

: Ok. And just I know this question gets asked a lot but well actually one thing I want to confirm. The tax free spin window that opens sometime in November.

I believe that's correct.

: Do you have a sense of date? Is it early late any specific date?

That I'm not sure.

: OK. Any - have there been any additional thoughts or anything at on their ownership?

As you know you know they have consistently have stated on there earnings calls over the last couple of years that were not strategic to them and that the intention reduced their ownership position at some point and time. Probably sooner rather than later. And they continue to state that both to us and to the public.

: OK. And then I guess finally any - can you give us some perspective on what clients are sort of saying or feeling or anything on issues. Is there anything you know beyond what they were talking about you know over the past couple of quarters in terms of business continuity.

Not really I think the - certainly that issue seems to receded in to the background except for the fact that business continues to be declining continues to be a very high priority a much higher priority than it was a year or 18 months ago.

: Great. Great quarter again. Thank you very much.

Thank you and with that I'd like to wrap up the call and thank everyone for joining us today. Thank you.