高知特 (CTSH) 2002 Q4 法說會逐字稿

Good afternoon. My name is Mitch and I will be your conference facilitator today. At this time I would like to welcome everyone to the Cognizant Technology 2002 fourth quarter earnings conference call. All lines have been placed on mute to prevent 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 1 on your telephone key pad. If you would like to withdraw your question press star, then the number 2. Thank you. I will turn the call over to Ms. Stephanie Prince of FD Morgen-Walke.

Thank you operator. By now you should have received a copy of the company's fourth quarter earnings release. If you haven't, please call FD Morgen-Walke at 212-850-5600. 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'd now like to turn the call over to Kumar. Please go ahead.

Thank you, Stephanie. Good afternoon, everyone. Thanks for joining us. The fourth quarter was another strong quarter for Cognizant marked again by strong revenue growth. We finished the quarter with sales of $67 million, up 54 percent year-over-year. And 9 percent sequentially. Pro forma earnings per share, which excludes $1.7 million in transaction costs related to the IMS Health exchange offer was 49 cents. This compares with 29 cents per diluted share in the fourth quarter of 2001. Revenue for the full year of 2002 was $229.1 million compared to $177.8 million in 2001. Pro forma earnings per share was $1.71 per diluted share. 2002 results also substantially exceeded the initial guidance that we provided at the beginning of 2002. $200 million in revenue and $1.25 in EPS.

We exceeded our own expectations as well as Wall Street's because of Cognizant's success in winning and rapidly ramping up services to large strategic clients. As we define them, strategic clients have the potential to grow quickly to an annual run rate of $5 million to $40 million or more. Strategic clients are usually characterized by offshore programs that are driven top down by the CIO or other executives and strongly incentive to achieve cost savings. Strategic deals are a new phenomenon in the marketplace reflecting the mainstream acceptance of offshore. Cognizant won a high share of these deals in part because of the capabilities we have assembled for our fourth generation offshore business model. Cognizant has industry leading capabilities to quickly analyze client applications portfolios, to determine what to move offshore. Program and change management capabilities to partner with clients to manage large programs involving substantial change, and industry leading processes for knowledge transfer and metrics based engagement management.

We also now have the scale to take on the largest of offshore assignments. Application management continues to outpace development work due to new deals quickly wrapping up as companies continue to look for IT cost savings. For the fourth quarter, application management services represented 59 percent of revenue and drew 68 percent year-over-year. Application development and integration revenues grew 37 percent year-over-year in dollar terms and accounted for 41 percent of revenues in the fourth quarter. We have had substantial level of success in cross selling development integration services to clients who engaged us initially for applications management. For example, one of our successful service offerings is portfolio rationalization.

Many clients inherited a plethora of overlapping and duplicative systems on incompatible technology platforms. From the technology spending boom in the late 1990s as well as from the [INAUDIBLE] activity during that period. Cognizant's portfolio rationalization service helps clients rationalize these applications to fewer platforms achieving a reduction in substantial infrastructure and support costs. In addition to offshore cost savings. We will also work with clients on an architectural road map to transform these valuable Legacy systems for new needs for intra and inter enterprise integration and e-based business. We also saw continued [INAUDIBLE] in intergration and other offerings, including data warehousing, CRM, and e-business. During 2002, we clearly established Cognizant in the top tier of our peer group, widening the gap between ourselves and other competitors with the successful execution of our industry leading fourth generation services model. Unlike several of our competitors, we have remained focused entirely on business applications for business end users, avoiding unrelated activities such as R&D services.

Based on business applications revenues we are one of the largest offshore players. We believe that our long-standing vertical organization best leverages industry and domain knowledge, which will remain key as the industry involves. The fourth generation Cognizant model also has executive management, practice leaders, and senior client partners located close to clients in the U.S. and Europe. The executives consult frequently with clients and are empowered to make fast strategic decisions to meet client needs. This is in contrast to the less responsive offshore-centered decision making structure of many competitors. Our unique service model is focused on delivering high value and rapid responses to our clients technology needs with a highly competitive cost structure.

Continuing our record of robust repeat business during the quarter, approximately 85 percent of our revenue came from clients who have been working with Cognizant for at least a year. We also signed seven new clients in the fourth quarter of which three were strategic clients. We signed 16 strategic clients for the full year 2002. We also recently announced the successful completion of the exchange offer to distribute IMS's majority interest in Cognizant. It closed on February 6th, 2003. We believe the dramatic increase in liquidity and float will be to the benefit of our shareholders. In sum, Cognizant ended 2002 in tremendous momentum as we begin life as a totally independent company we are very excited about our future.

The ramp up of the large number of strategic clients signed in 2002 gives us a high degree of confidence in our outlook for 2003 as do the potential opportunities in our new deal pipeline. For the first quarter we expect revenues of at least $31 million and EPS of at least 50 cents. We are also pleased to raise guidance full year to $305 million in revenue and at least $2.12 in EPS. EPS guidance excludes an expected first quarter charge related to the IMS exchange offer. With that, let me turn you over to Gordon.

Thank you Kumar. Good morning -- good afternoon, to everyone. I'd like to provide additional information on the fourth quarter and then discuss our financial expectations for Q1 of 2003 and beyond in more detail. Revenue for the fourth quarter was in line with our update to investors in early January. Our core businesses remain solid and performed well. Our pipeline is robust, and we are confident in our ability to continue to deliver healthy sequential revenue growth during this year. Both application management and application development grew sequentially in Q4.

During the quarter, application management grew 11 percent sequentially and application development and re-engineering grew 7 percent sequentially. For the full year, application management grew 43 percent and application development and re-engineering 13 percent. As anticipated, we experienced significant growth in our financial services sector during the fourth quarter. Financial services, which includes our practices in insurance, banking, and transaction processing, grew to 43 percent of revenue in the quarter.

Many of the strategic clients won during 2002 were in our financial services sector. The growth of this sector is a result of these accounts beginning to ramp up. Health care was 22 percent of revenue for the quarter. Retail and manufacturing was 16 percent. And information services was 11 percent. The remainder of our revenues came primarily from other service oriented industries as well as our alliances.

During the quarter, approximately 88 percent of revenue came from clients in North America. This percentage is up slightly from Q3 of 2002 and reflects the ramp up of strategic accounts we have won over the past year. The vast majority of these new strategic accounts were in North America. We are starting to see an increasing interest level in northern Europe for offshore services. As a result, we would expect this he trend to slowly reverse in the future. We added seven new customers during the fourth quarter. Our active customer base remained at approximately 105. As Kumar mentioned, three of the clients won during the quarter have the potential to become significant revenue sources for us in the future.

Turning to costs, costs of revenues increased 65 percent for the quarter as compared to the fourth quarter of 2001. The increase is almost entirely due to additional technical staff both on-site and offshore required to support our revenue growth. We increased our technical staff by over 2100 people compared to the fourth quarter of 2001, and ended the quarter with over 5500 technical staff. This is a net increase of almost 900 staff from September 30th, 2002.

Gross margin was 46 percent for the quarter, a decrease of 340 basis points compared with our gross margin in the fourth quarter of 2001. And a 20 basis point decrease compared to Q3 of 2002. For the full year, gross margin was 46.4 percent. The primary driver of the lower gross margin in 2002 compared to 2001 was the accrual of a higher level of bonus payout in 2002 compared to the prior year.

SG&A expenses, including depreciation were 17.6 million, up from 12.4 million in 2001. As a percentage of revenue SG&A was 26.2 percent for the fourth quarter, a decline of 240 basis points from the fourth quarter of '01, resulting from our ability to leverage the prior year's sales and marketing investment as well as continued cost control actions. Pro forma operating income for the quarter increased 47 percent to $13.2 million from $9 million from the fourth quarter of 2001 and our operating margin was 19.8 percent down approximately 100 basis points from the fourth quarter of '01 and consistent with our operating margin in Q3 of 2002. We were able to maintain our operating margin in 2002 despite our additional increase in bonus accrual due to our ability to leverage prior sales and marketing investments and as well as our continued cost control actions. Interest income for the fourth quarter was $503,000, compared to $495,000 for the fourth quarter of 2001. Interest income increased only slightly despite higher cash balances due to the significant drop in short-term interest rates. We had $146,000 foreign exchange loss during the quarter largely due to the strengthening of the British pound.

As Kumar mentioned, during the fourth quarter we incurred approximately $1.7 million of expenses associated with the recently completed splitoff exchange offering. These expenses included legal, audit, banking and printing fees. As previously announced we will incur additional nonrecurring expenses in Q1 of this year associated with the completion of the splitoff. Our GAAP tax rate was 23.3 percent for the quarter and 23.4 percent for the full year. On a pro forma basis, which excludes the splitoff related expenses, our tax rate was 22.5 percent for the full year and 20.4 percent for the quarter. For the full year, the pro forma tax rate was 90 basis points lower than originally anticipated due to the finalization of our transfer pricing analysis. The pro forma rate for the fourth quarter was lower than the full year rate due to the year to date catchup booked in the fourth quarter to bring the full year rate to the proper level. The Q4 reduction in the pro forma tax rate benefit EPS by 2 cents for the fourth quarter and the full year. We believe it is reasonable to anticipate that we will maintain the lower tax rate in 2003.

Turning to the balance sheet. We finished the fourth quarter with over $126 million in cash. An increase of $3 million for the quarter and $41 million for the full year. During the fourth quarter, operating activities generated $21.6 million of cash. Financing activities, specifically the exercise of stock options, generated an additional $7.1 million of cash. These amounts were largely offset by $15.1 million of capital expenditures including expenditures on our Indian construction program and approximately $10 million for the acquisition which we completed during the quarter. For the full year, we generated $56.7 million of cash from operations and $20 million from financing activities, primarily stock option proceeds. We spent $22.3 million on capital expenditures and $13.2 million on acquisitions.

We recently completed the second of three new company owned development facilities in India. The first facility, located in Pune, is 135,000 square feet and will house close to 1,000 programmers once full. The second techno-complex, which just opened, is located in Calcutta. It is 115,000 square feet and will also house close to 1,000 programmers. The third techno-complex located in Chennai will contain 370,000 square feet and will house well over 3,000 programmers. The first phase of that facility comes on line in spring of this year. Late last year we accelerated the construction program on the Chennai facility and now expect the final phase to be completed in the fall this year. Due to the success of this initial construction program and our faster than anticipated head count growth we will likely launch a second phase of construction during 2003 to meet our infrastructure needs for years to come. As a result, we expect 2003 capital expenditures to exceed 2002 levels and to be in the range of 30 to $35 million.

Our collection of trade receivables during the quarter was very strong. Based on our $41 million balance on December 31st, we finished the quarter with a DSO, including unbilled receivables of 56 days, well below our DSO target of 70 days. Excluding unbilled receivables our DSO was 50 days. Overall, our billed and unbilled AR balance grew by only $1.6 million over the quarter. The quality of our receivables portfolio remains exceptionally strong. Of our total AR balance only 2% is over 90 days old. Our unbilled receivables balance is $4.3 million at the end of the fourth quarter. During the fourth quarter, 21 percent of our revenue came from fixed bid contracts. The percentage of revenue from fixed bid contracts declined in the fourth quarter from 27 percent in the third quarter -- [INAUDIBLE] time and materials pricing methodology.

Turning to head count, at the end of the fourth quarter, our worldwide head count, including both technical professionals and support staff totaled approximately 6150. This represents a net increase of over 900 people during the quarter. Roughly 30 percent of the increase resulted from the acquisition we made in the quarter. 30 percent from were college graduates entering our training program, and 40 percent were lateral hires as experienced IT professionals. Annualized turnover was 9 percent during the fourth quarter, including both voluntary and involuntary. Voluntary turnover was approximately 5 percent annualized and involuntary was 4 percent. For the full year, total turnover was less than 12 percent.

Utilization during the fourth quarter was down sequentially as a result of significant continued hiring during the quarter. On site utilization was approximately 88 percent. Offshore utilization was 69 percent, excluding recent college graduates who are in our training program. Including trainees, offshore utilization was slightly less than 60 percent. The hiring in the latter part of 2002 positions us well to meet market demand in 2003 as a large number of college graduates complete their six month training program and become eligible for billable positions. At the end of 2002 we had over 700 people in our training program.

I'd now like to comment on growth expectations for this quarter and beyond. As Kumar mentioned, we are comfortable with our ability to deliver revenue in the first quarter of at least $71 million. We continue to have significant revenue visibility due to our high level of recurring revenue and the long term nature of our customer relationships. In fact, today we have customer commitments for well over 90 percent of our first quarter revenue guidance. For the full year we expect revenue to be at least $305 million. During the first quarter, we intend to continue to closely monitor our spending and expect your operating margin to remain in the 19 to 20 percent range in line with our historic margin levels and prior guidance. With this expected level of revenue growth and our expected operating margins we are currently comfortable with our ability to deliver EPS of at least 50 cents for Q1. As Kumar mentioned, all guidance excludes the impact of previously announced nonrecurring expenses we incurred in the first quarter related to the splitoff exchange offering. Based on business trends we currently expect the full year for at least $2.12. We expect the vast majority of our 2003 growth to come from our existing client base, specifically the numerous strategic deals we won in 2002. Based on the feedback we have been receiving from these clients and their intentions to leverage the advantages of offshore, we are quite optimistic about the outlook for this year. Kumar and I would now be happy to answer any questions. Operator?

Ladies and gentlemen, if you would like to ask a question, please press star, then the number 1 on your telephone key pad. We will pause for just a moment to compile the Q and A roster. Your first question comes from Andrew Steinerman with Bear Stearns.

Hi, Andrew.

Mr. Steinerman, your line is open. That question had been withdrawn. Your next comes from the line of Adam Frisch with UBS Warburg.

Hey guys, good afternoon.

Hi, Adam.

Gordon, if you could walk through -- I want to adjust margin pressure here. And some of your peers have been experiencing pressure here. Can you walk us through where you -- why you feel so confident about maintaining an operating profit in the 19 to 20 percent range. And secondly, how you are prepared to address the potential pricing and wage pressure that we might potentially see in '03?

Sure. I think the key thing there is our margins are 19 to 20 percent. Many of our competitors historically have been running at margins well above that. And you know, for the last several years we have taken the philosophy to reinvest anything back into the business above 20 percent. What that means is we have been making already for the last several years the investments in sales and marketing, and client partners and industry practice leaders that many of our competitors are now increasing expenses for and as a result their operating margins are coming down.

Our planning assumptions are based on our average realized pricing remaining flat in 2003. We had flat pricing in 2002 and we expect that to continue. As you know, in 2002, as I mentioned, we accrued bonuses at an extraordinarily high level. That provides us some flexibility to absorb any wage increases that may occur in 2003 as we return to a more normalized bonus accrual. But once again, based on everything we know at this point we are comfortable staying in the 19 to 20 percent operating margin, which we believe is the appropriate level for our business.

Cool. Turning to growth. Your thoughts on a response to some growing competition from larger U.S. vendors. Do you see an opportunity to further reduce your cost of delivery by maybe expanding to include China or some other areas around the world? And then specifically if you could address new growth areas that you are potentially looking into within the BPO space.

Sure, Adam. The answer to your first question, I think we are seeing increased interest in this marketplace from some of the larger U.S. vendors, particularly Accenture and IBM Global Services. And they are in many of the deals we compete in. They price pretty aggressively. So far, we have not seen them win any of the larger deals or have not really become so far a significant competitive threat. Right now, their scale is -- I believe Accenture has, you know, less than 1,000 people in India. Clearly, the market share they are going to garner in this business over the next few years is going to be quite small. In the near term, we don't really view them as a factor.

We really are more concerned about the traditional offshore competitors who are really the ones that are winning most of the deals. In terms of lowering cost structure, we are looking at other locations. We don't view that frankly as a means of lowering cost structure although short-term that may be the case. Most of the countries have, you know, similar or higher GED per capita relative to India. So I'm not sure the cost structures will be lower. We do believe that's important, though, for expanding our pool of resources and for providing clients with opportunities to diversify their risk by locating in more than one country. Did you have another question?

Yeah. In terms of BPO, how are you guys addressing that?

The BPO market, we've been somewhat more cautious than many of our competitors because the bulk of the business that has been going to India to this point has been call center business, a lot of it telemarketing business, which we view very much as commodity business with margins that may or may not be sustainable. We have -- we are now seeing more recently more business in sort of what I would describe as vertical business processes which are deeply intertwined with the clients's business process where the business cost and the stickiness of the business is more akin to our traditional IT services business. And where also our knowledge of verticals and our knowledge of technology is relevant in improving business profits. We have started pilots with clients in some of those areas. We have not included any of those revenues in our guidance although we have allocated some costs for that in the EPS guidance we have provided. And we will be ready to talk more about the specific verticals and the specific activities that we are pursuing I think in the next couple of quarters.

Do you think it's going to be anything that adds material revenues in '03 or are we talking more '04, '05.

Some revenues in '03 but it will be small relative to the IT services.

And none of that is in the guidance we gave today. None of that revenue.

Gordon, any ramping up in quarters that you see being better in terms of top line growth with others. Or should we expect relatively consistent sequential growth during the year?

There are always anomalies because of a specific client ramping up in a quarter, but, really, very little seasonality in the business.

And finally, hiring trends. You had a monster quarter in the fourth quarter. And as well I guess in the third quarter as well in terms of adding new head count. What do you expect in '04? How will that play out? I guess a total hiring plan, and then is it going to be a little bit slower in the first half of the year because you had a monster hiring trend in the second half of last year?

In hiring there is seasonality, the college students tend to come on in the summer and in the fall. Q1, we will have a net increase in head count but certainly it will not be at the same level as in the second half of last year. That's due to the college seasonality. Head count for the full year, where we end up, is going to depend largely on how strong demand is to deliver the results -- to deliver the guidance that we talked about today, we would not need to add large numbers of people. If we see additional demand, if we continue to win strategic accounts, you know, we will adjust our hiring plans accordingly. As you know, there are two types of hiring that we do. One is long lead cycle college hiring. We are putting our offers out for people who join in the summer. And then we do lateral hiring, which is very short cycle hiring. Last year because of the strong demand we did a lot more lateral hiring than normal. So as this year materializes, we have the flexibility to speed up or slow down that lateral hiring. But clearly we will add people again this year. And clearly we will add people in the first quarter.

We are effectively gearing up to recruit enough people to end the year with about 8,000. However, that would imply, obviously, much higher revenues than we are currently guiding to. So that will depend on seeing our clients ramp up at a continuing aggressive rate.

So the people that you have now that are billable and both in your training program, is that the head count that you need in order to deliver the top line growth that you spoke about? Or do you --

Yeah. In order to deliver the guidance that we provided you today, we already have the people.

As the people come out of training.

Sorry. Could you say that again?

To deliver the guidance we gave today, including our trainees who will graduate from the classroom, that would allow us to essentially deliver the $305 million.

Thanks guys. Great quarter.

Thank you. Thanks.

Your next question comes from Mauyak Tandem with Janie Montgomery Scott.

Congratulations. Terrific quarter.

Thank you.

Just a couple of questions here. I guess the first question is leading up to the Indian budget. Kumar, do you expect any kind of change in the tax policy in India as relates to the offshore outsourcing companies?

Based on everything we are seeing right now and based on the guidance we are getting from the advisors over there at this point they don't expect any material changes to the tax policy. Obviously, you never know until it's done, but based on our current intelligence, our belief is that there will not be any material changes.

There has been some talk, right, it's been in the news media about policies that would go into effect that would phase out the tax benefits for offshore companies faster than expected?

That's correct. A commission has been set up to look into the India budget. That's one of the thing suggested. However the finance minister in India came out publicly in the press and said he did not support that proposal.

So your tax rate guidance going forward is 22.5 percent; is that correct?

that's correct.

I guess the second question is it seems like the deals are getting bigger. Are the landing times longer now on some of these large deals? And what about the rates on some of the bigger contracts down the road? Do you expect pricing to be firm on them or are clients asking for more attractive rates?

In terms of the timing, the sales cycles tend to be larger. These are larger deals so they take longer to -- clients go through an extensive selection process and a fairly long contract negotiation process. The contracts are more complex. But conversely the ramp ups tend to be a lot faster once the deals have been won. In terms of pricing the market has tiered itself. And many of these large deals are going to the three or four top players. I'd say most of them.

So the pricing environment will really depend I think on what the top three or four players do. And so far we have seen people like InfoSystems holding fairly firm on prices. So, you know, we haven't seen any pressure there. And I think given the demand we are saying capacity utilization is going to get very high in the industry. So, again, that would probably argue against a lot of price pressure in the near term.

Kumar, could you quantify the time period over which these deals I guess begin to impact your performance and relative to some of the smaller deals on average? And also what are the bill rates?

Well, I think you have already seen the deal impact our revenue growth this year. That will continue. And we've added many more in the second half of the year. So we'll see many more of them kicking in in the course of the year. In terms of bill rates, on average -- unlike for InfoSystems, which had Legacy clients with much higher bill rates, we have always had prices around $24 an hour offshore, 70 or so on-site. And that has not changed except for some volume discounts on very large deals. But the volume discounts are largely offset by lower costs to serve the clients because the large deals are also cheaper to manage. So on the whole, we will not see any decline as Gordon mentioned, we expect our average prices to remain pretty much flat as these deals ramp up.

With $70 on-site and $24 offshore, is that fair for the quarter for the rates?

Yeah.

Our average was consistent with last quarter. Right around there.

I guess the final question here, your offshore on-site mix did that impact your gross margin at all, Gordon?

Instead of 32 percent on site we were at 31 percent. So not -- no material impact.

But given these ramp up, these big deals, I guess one would think that your on-site component will rise faster. I'm wondering if your guidance on gross margins might be also affected by that as you look into '03.

These larger deals tend to be more focused on application management and you can do a higher percentage of that work offshore once it's up and running. The on-site tends to be for a fairly short period. Our expectation of on-site and offshore mix is that it's going to stay in the same range it's been for sometime.

Terrific. Congratulations guys.

Thank you.

Your next questions comes from Mosha Katri with SG Cowen.

A couple of questions, can you comment on the trends in you application development business, that's number one, and then have you seen any impact from your clients or leads with the recent tensions on the India-Pakistani border.

In terms of development and integration, we have clearly seen a revival in that business this year. And sequential growth the last couple of quarters even though it's not as strong as the application management business. And the business is really characterized, I'd say, by small development projects -- when I say small, a couple of million dollar projects. But not 10 and 15 and $20 million that we were seeing years ago. And these are projects with quick ROI, strategic transformation of the projects that people are trying to embark on during the e-business boom. But collectively, these projects could lead to significant transformations in the business. I mentioned some of the areas we are seeing fairly strong demand, data warehousing and portfolio rationalization, for example, and in e-business.

So a lot of it is pretty much similar to what we've seen in Q3 as well, right?

Exactly.

No change there?

Yeah. The trends we saw in Q4 were right in line with what we saw in Q3.

And how about the recent tensions on the borders? Did that do anything?

I haven't seen it spill into the pipeline so far. The pipeline is extremely robust with clients looking to us.

One of the things we saw -- interest into their 2003 budget cycle in the late fall we saw a healthy increase in our pipeline as people were looking at how do they make the budgets work for 2003 and focus on offshore as one of their initiatives. So the pipeline is robust.

What was your top five client base, and then top ten for the quarter?

Top 5 was 39 percent of revenue, top 10 was 57 percent.

And you mentioned Europe you are starting to see some revival or some interest in demand probably more from the UK markets. Can you talk more about that. And then what did Europe account for as a percentage of revenues?

Europe as I mentioned was modest, about 12 percent of revenue, actually down in terms of revenue for Q3. What we started seeing in Europe early signs of offshore [INAUDIBLE] particularly UK and European in specific industries. It's close to where the U.S. was two, three years ago. We're investing time and money into Europe to make sure we are well positioned as that window of opportunity opens. We think it will start to open this year.

Assuming all this interest -- you are deriving this interest yourself and it's not via the partnership or the relationship with CSC? Am I correct?.

This is throughout. And once again you won't see it materialize into substantial revenue this year but we will start to receive strategic deals and we'll win our share. Those take a while to ramp up but we are starting to see signs for it.

We are approximating I wouldn't say a large number but a few strategic deals in Europe which are a similar scale to the ones we've been seeing in the U.S. So we are hoping that that's the beginning of a trend.

Thanks, guys.

Thanks, Mosha.

Your next question comes from George Price with Legg Mason.

Good evening. Thanks for taking my questions.

Hi, George.

How are you guys doing?

Good.

I guess first of all wanted to -- or if you could give me a little bit more color on the tax rate, what -- you know, what helped drive down the quarter and why you are going to be able to sustain that going forward. Does it have to do with any of the new area facilities coming on line or is it something else?

It primarily has to do with as we finalized our transfer pricing analysis during the year in the fourth quarter. We had made some assumptions that turned out to be too conservative. So that -- it has nothing to do with the facilities over there. And given that this transfer price today that we just completed provides the basis for 2003, absent regulatory changes, we're confident that it will stay at least at the lower rate.

Okay. Is that -- I mean, is that something that sort of gets reviewed or, you know, or blessed or something by, you know, outside sources?

This is something that we did in conjunction with outside advisors.

Okay. And I guess talk maybe a little bit about your thoughts going forward on potential acquisitions. You know, be they tuckins or do you see any additional opportunities like you saw with United Health Care or Amex or sort of an easy carve out?

Yes. I think we are continuing to see good deals, George, but we are extremely selective. And you know, we will probably only do a very few acquisitions. We are looking at areas like CRM and ERT where we are seeing strong demand as clients move beyond the initial incrementation phase inside many of these things and want upgrades, ongoing maintenance, ongoing process integration with other systems and are thinking of moving a lot of that work from the traditional big five suppliers to offshore. We are seeing strong demand in those areas, the enterprise applications. So we would be interested in deals there. We are always looking out for strong vertical expertise. And the other place that we are looking for is in Europe, although, again, we have looked at a lot of deals and so far have not found anything we considered the right fit for us.

And we do like the concept doing small acquisition they are easy to integrate. The integration of the two deals we did last year went very well. We are now comfortable with our ability to integrate small transactions.

Okay. And next question is really on, you know, in situation where you are one of a few preferred providers for some of these larger companies that are obviously moving more aggressively offshore and typically, you know, choose a small number of larger firms. Yourselves, sometimes a couple of your competitors. Do you feel in these situations, you know, that you are able to take share within those kinds of relationships relative to your competitors most of the time?

Those are the best situations for us because we end up getting, you know, a very high share of the business when it is left up to individual decision makers because in those situations clients see how much more responsive and how much more capable Cognizant is relative to some of the sort of India-centric competition. And in cases where there have been multiple suppliers we ended up with a very large share of the overall business. So, yes, the answer is we are able to compete very effectively and get a large share of that business.

Okay. And a couple of housekeeping items and I'll turn it over. On the -- you mentioned seven new clients, three strategic clients, you know, 16 strategic clients for the full year. Maybe , can you comment a little bit on how the others -- obviously the three in the fourth quarter are relatively new, but any comment on the particular demand trends in terms of the other strategic clients in terms of how they are ramping up.

Obviously the fact that we increased guidance and that we used the words at least in the new guidance that we gave indicates we are optimistic with our ramp up. The vast majority of our growth in 2003 will come from clients we have already won. Clearly we are seeing a trend towards clients ramping up. Clearly we've seen a trend of clients banking savings into their 2003 budgets. How fast they will ramp up -- that we don't know yet, but the signs we are seeing are looking good.

It's important to point out that the assumptions we've made for your guidance is extremely conservative. So, in providing guidance we have not assumed sort of the higher rates of ramp up that we have, in fact, recently seen from these strategic clients. So we've assumed a more traditional slower rate of ramp up. And so if these clients, in fact, do ramp up at the rates we've seen more recently then there is upside to what we've provided.

Has that continued?

So far it has continued, yes.

And Gordon, I don't know if you provided the actual segment revenues for APdev and AP management and then the billable split, on-site and offshore.

Head count on-site offshore worked out to about 31 percent on-site. And what was your other question?

The actual segment revenues.

Sure. Hold on a second. Application development was about $27.5 million. And application management was about $39.5 million for the quarter.

Thanks very much.

Thanks, George.

Your next question comes from Joseph Affi with Jefferies & Company.

Hi, guys.

Hi.

I wanted to delve into the application maintenance line and talk about the ongoing sales cost that might be embedded in there. If that business is recurring like in nature and after it's been on line for a while what are some of the dynamics going on underneath and the amount of sales, I guess marketing costs that you need to kind of sustain that recurring like revenue stream once it's kind of come on line?

It clearly gets larger. As I mentioned, what we do is sort of to actively cross sell the development and integration services. You know, it's clear that large clients are cheaper to manage than small and medium sized clients, which is why we are able to offer them certain volume discounts. But we don't -- although, in theory, you know, we could essentially not have any sales effort against a large application management client we never do that because we see so much potential both for getting new application management business and just as importantly for cross selling the development and integration services. But you are right, if you take sales effort as a percentage of revenue on larger strategic clients it is a lot lower than the company average.

But even that sales effort on those clients is still being directed on an ongoing basis into kind of new business rather than into -- to a large degree the business that's being maintained.

That's correct. That's correct. Yes.

And then just on the development line, you know, clearly really strong results, and you know, much better than you see generally across the IT services industry. I know you mentioned, Kumar, a couple of things that were working in that group. But I was just wondering, if you are seeing the demand or are you getting the business, I guess is the right way to do it -- is it more of a pull or is it a push? Are you inside the clients and convincing them that the ROIs are high and then are they funding the project. Or are you aware of the fact they were going to do these projects anyway and they were going to choose maybe an offshore player to help them do it and you won the business?

I think it is a mix. I would say generally clients have some idea of their agenda. What we are sort of increasingly doing is showing them how to break up that agenda into small chunks with quick ROI and demonstrating that ROI to them. So to that extent, there is a little bit of a push, say, you know, that given the offshore cost structure and if you do this piece we can deliver this result fairly quickly. But generally the overall strategic -- we don't generally try to set the overall strategic agenda for the clients. They have already decided which areas they want to focus on and have dealt with other management consulting firms to develop that.

Great. And then maybe also Kumar if you could maybe give us some thoughts on 2002 and some of the things you learned in ramping these larger maintenance deals, some of the things that you learned along the way in 2002. And I guess also then how maybe you think you stand up competitively in your capacity to ramp these deals when you started the year and when you ended the year versus your competitors.

Well, you know, clearly, we've now gotten our scale up to a point where, you know, going back 18 months on a scale, in fact, in itself and we add 3,000 employees was something of an issue relative to the competition with 6200 and growing fast, it's becoming much less of an issue in these large deals. And one of the things we did well, and we did ahead of the rest of the pack was to bring in the program management and change management capabilities and work very actively with clients on these large change programs because as the deals got larger obviously there was a lot of dislocation of people, need to manage that change process, to manage a large program across multiple divisions in a company, to coordinate processes, to ensure that the cost savings that people are depending on come through in their budgets and are -- you know we close the loop on that. All that have sort of process of managing an offshore outsourcing program across an organization Cognizant was probably the first and to put in and is probably a leader in being able to do all that.

Also, just the processes like knowledge transfer, you know, for example,. With most clients we guarantee knowledge transfer in eight weeks which is an aggressive schedule but we invariably are being able to meet those schedules because of the processes we have. And finally, very extensive metrics to manage engagements. We also have a thing called E-cockpit which is sort of a system that allows client CIOs to on a day-by-day basis monitor those metrics across the entire engagement which gives them a lot of visibility into how all the engagements are going. And that helps a great deal also in moving fast.

Okay. Great. And then just finally, one thing we don't hear about too much, you know, we obviously have got a tremendous ramp in in the number of professionals you have got working for the company. You don't hear too much about the tools and mechanisms being put in to help manage this very large addition of people to the company over the last year and into the future. And how do you manage this many people? And what do you look at as some of the important things that you want to accomplish in that area?

I think on the technical side of Cognizant -- of course, our processes have always been strong with the CMI processes and the basic metrics management structure. We are at P-CMM level 5 on how we recruit, train and create management levels and all that training. But another respect in which I do believe where we are ahead of the competition is in the management processes, things like forecasting profitability and understanding a lot of detail what drives our cost structure, how to price extremely accurately for a given margin, and to be able to forecast that margin. So sort of forecasting revenue, forecasting the sales pipeline, pricing, and forecasting margin. All this is tough. And we push those processes down to the next level in the organization and given them the tools and the processes to be able to manage those things. So I think all of those things have helped us to manage growth effectively and accurately maintain revenue and profitability.

Great, thanks a lot, guys.

Thank you.

Thanks, Jeff.

Your next question comes from Cynthia Holden with RBC Capital Markets.

I was wondering if the you could address a couple of questions. First on the -- we did we a -- we did see a sequential decline from IMS or a related party. I was wondering if you could address that and how you would look at that revenue for '03.

I would not view that as a trend. We signed a multi-year agreement with IMS and I think there was a combination of slightly fewer billing days and timing of a couple of projects. In looking at '03 -- our planning assumptions are it will be around $20 million of revenue.

And did you give the offshore and on-site billing rates for the quarter?

Average realized rates were very consistent with what we experienced throughout the year. Around $24 per hour offshore. And to $69 to $70 on site.

And in terms of -- you talked about the fixed price billing you said it was down only because you had a lot of contract starts, start-up, and customers wanted to go T & M, should we figure that the way these contracts are configured later on they will go to fixed billing? I was wondering if you could comment on what customers want to do from a billing perspective.

I think even within a single customer it will be a mix of the two. My expectation is that percentage of fixed bid will move back up again. Sometimes when you first start with a new client the first projects will be on a T & M basis, and also the timing of some development projects and so forth. We were surprised -- surprised that the mix shifted that much. And I think it will probably reverse itself a little bit. You know, we clearly want to continue to pick fixed bid up as a percentage of revenue. We think it is a good business ultimately to get it into the low 30s. It will bounce around a little bit but I think the trend will be up slightly from where it is.

Can you comment on what is happening on the development side? I know management continues to grow. But are you getting a sense that customers on the purchase side, you mentioned areas that were stronger in development. What is your sense of where customers are in terms of development spending? Do you think we are going to see, you know, this start to accelerate or do you think they are still fairly cautious on starting development projects?

I am still not seeing you know the sort of very large development projects that we saw during the e-business boom. I don't think anyone is thinking in terms of 15, $20 million projects. I think, though, we are seeing an increased level of activity in the small to midsized projects, from half a million dollars to 2 to $3 million, which drive incremental value from investments that have already been made a couple of years ago. I mean, people have spent a lot of money on technology. Not all of it is being leveraged and used. And things that help you leverage like that, and a good example is, you know, customer -- is the data warehousing investment to leverage information from systems and make decisions better, process of [INAUDIBLE] and CRM and things that have nature. We see that happening quite a lot.

Great. Thank you.

Thanks, Cynthia.

Your next question comes from Andrew Steinerman with Bear Stearns.

Sorry about the technical problems before.

You decided not to hang up.

No. I kept on going. One quick comment. If you mentioned this at the beginning I'm sorry. Just obviously on all investors minds is kind of looming risk of the Iraq situation. Has any client, you know, kind of expressed anything that was telling to you in terms of any kind of intentions, what-if scenarios and obviously how you guys have prepared for contingencies?

We haven't seen anyone particularly talk about Iraq and the implications of that, Andrew, but, you know, since September 11th, you know, business continuity planning and the overall risks of doing business offshore have clearly been front and center with clients. And so business continuity planning is always a key part of any assignment. And we have multiple levels of protection. We back up everything we do every day in a different center. We -- as you know, we have typically about 30 percent of the team on site with the client. And we have detailed plans as to what they can take over if the offshore centers are not able to operate.

We have plans as to which people are critical, which projects are critical and how people will be redeployed so that, you know, we are able to plan around most of the sort of imaginable contingencies, I guess. We haven't specifically seen people become concerned because of the Iraq war. I guess the only direct impact we could possibly see is travel restrictions to India, which also happened during the time of the Indo-Pakistan flare-up about a year ago. But in the end did not have that much of an impact on the business.

Have you heard about travel restrictions or are you just speculating?

No, I'm just speculating. I cannot think of any other direct impact on the business from an Iraq war except you know just slowing down of the U.S. economy and travel restrictions are the only things that I think -- that we can conceive of as direct impacts.

And to be clear, to date we have not seen any impact.

Right.

Can we just say potential Iraq war?

Yes.

That is a good idea.

Thanks so much.

I think we have time for one more question?

Your final question comes from the line of Sandra Notardinado with Adams, Heartnet and Hill.

Hi. Thanks for taking my question. First I was just wondering if, Gordon, you could comment on what the companies at the 16 strategic deal level are banking in as cost savings with their budgets?

Sandy. It's all over the place. A lot of it has to do with are they based in a major metropolitan area or are they based in a small city. It's -- on -- anywhere from 20 to 50 percent.

So similar to 2001, but it becomes company specific?

It's very company specific. But a, yeah, keeping it substantial, enough that it gets the attention of the CFO and the CEO.

What are you modeling in terms of wage rate increases in 2003?

We -- in 2002, as you know there were no increases. In 2003, we haven't finalized anything yet, but our expectations is they would be quite modest.

And the last question I have is around something more macro. Are there any things that you are working on to help capture some of the spending around IT and network security? And do you see this as a potential area for growth for Cognizant?

We actually have quite a strong security practice. And yes, we do a lot of security consulting work. It's not huge in dollars in the overall context of our business. But it's considered strategically obviously very important by clients. So, yes, we expect to continue to do that.

Have you noticed that that's become increasingly important?

Oh, sure. I think you know, with nearly all e-business-related projects and development projects which involve significant server and network infrastructure that's a key component. And one of the reasons, in fact, that clients give us business is because we have a strong security practice.

Is there an issue with having those types of initiatives offshore?

Not really because most of them do tend to be technology initiatives and I think clients are not really concerned with doing it offshore.

And what do you think that could be in terms of revenue for 2003, if you take out that way, if you manage it that way.

You know, the revenue from literally doing security work is quite small. I'd say a few million dollars. But they are part of much larger projects. And a reason why we win much larger projects. So the actual work we do on [INAUDIBLE] or nitty-gritty or sort of the security systems is usually typically quite small but it could be part of a much larger overall e-business or integration project?

Okay. Thank you.

All right. Thank you. With that I'd like to thank everyone for joining us today and taking the time to join us on our fourth quarter call. Thank you.

Ladies and gentlemen, this concludes today's Cognizant Technology's fourth quarter 2002 earnings conference. Thank you for your participation. You may now disconnect.