高知特 (CTSH) 2003 Q2 法說會逐字稿

At this time I would like to welcome everyone to the Cognizant Technology Solutions second quarter 2003 earnings release conference call. (CALLER INSTRUCTIONS) I would now like to turn the call over to Mr. Ian Bailey of FD Morgen-Walke. Please go ahead, sir.

Good morning, everyone. By now you should have received a copy of the Company's second quarter earnings release. If you have not, please call us at FD Morgen-Walke on 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 would 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. Kumar, please go ahead.

Good morning, everyone. Thank you for joining us on our second quarter earnings call. We're pleased to report that Cognizant continued its strong financial performance for the second quarter. We finished the quarter with sales of $87.4 million, up 61 percent when compared with 54.4 million in second quarter of 2002, and up 17 percent sequentially from the first quarter.

At the Bear Stearns conference in June we have indicated a revenue range of 84 to 86 million. Earnings per diluted share were 20 cents, compared with 14 cents on a split adjusted basis from the second quarter of last year and our previous estimate of 18 to 19 cents. We continue to be optimistic about growth prospects for the remainder of the year and 2004, and anticipate operating margin stability.

It is now becoming clear that offshore sourcing for services is a global mega-trend that is in the early stages of evolution. Although a few clients have outsourced 20 or 30 percent of their software development and maintenance work offshore, most clients cite levels well below this with substantial room for expansion. At the same time, there are a large number of companies which have never used offshore in a significant strategic way.

Most large users of offshore are very satisfied with their results and the recent Forrester (ph) CIO survey shows that the majority of clients feel that in addition to be more cost effective, offshore vendors are better in terms of quality, on-time delivery and skills availability than the large US IT service vendors. As a result there are plans afoot to substantially expand offshore outsourcing programs at a rapidly growing number of Fortune 500 corporations with large-scale programs that are driven top-down, with rapid ramp ups and impressive targets.

Cognizant is growing faster than its offshore peers because our business model is built for this new world of large-scale offshore. Through our industry-leading fourth-generation services model, we partner with clients on a process we call "transforming while performing" to drastically cut IT and business process costs, while better aligning the clients' IT portfolio with business needs. Our ability to develop and sell a multi-year plan to senior client executives and then lead its execution differentiates us from our competitors and allows us to ramp up client business at a much faster rate. Our single-minded focus on this well-defined strategic mission, combined with extensive investment in vertical expertise, local executive management and client partners and strong execution have driven our success. Our early investment in these areas continues to separate us from our competition as the industry grows.

Our consistent performance with legacy and new clients alike has established Cognizant as a top offshore firm. As a result of our strong execution, we continue to win new business from strategic clients. We define strategic clients as those which have the potential to generate $5 million to 30 million or more in annual revenues for Cognizant. This quarter we added four strategic clients out of a total of nine new clients. We continue to see strong growth across all our vertical business segments, especially in financial services and health care.

Last quarter we announced the closing of our acquisition of Aces, a small company that specializes in customer relationship management solutions. During the quarter, we successfully integrated Aces into our CRM practice across financial services, health care and telecommunications verticals. Aces generated 2.3 million in revenue for the quarter.

Our operating margins continue to be stable in the 19 to 20 percent range, and we expect that this will continue. The pricing environment continues to be stable, and the industry appears to be moving from a demand constrained environment to a supply constrained environment, which should improve prices going forward -- a strong demand reduces the need for aggressive pricing. The overall macro-economic environment with rapidly expanding money supply and lower tax rates should also help.

Also, Cognizant has substantial leverage available in its cost structure. We have historically invested at a much higher rate than our competition in sales and marketing, particularly in locally based practice leads and client partners, and although we expect to continue this, we are starting to gain leverage from our prior investments. We're also gaining leverage because our account management costs are lower for the new breed of larger relationships. At the same time we're benefiting from substantial reductions in unit costs for real estate as we move into our own buildings, as well as unit costs for other infrastructure, such as communications and computing. Finally, unlike some of our peers, we don't have legacy clients at much higher prices who want to renegotiate rates. For all these reasons we're confident of our ability to maintain 19 to 20 percent operating margins.

I should note that we have been able to deliver a consistent margin despite a drag of several percentage points in gross margin because of our very strong growth.

We saw some encouraging signs in demand for new development projects during the second quarter, and sequentially development and integration grew faster than applications management for the first time in several quarters; however, application management continued to outpace development on a year-over-year basis. As a percentage of revenue, application management services grew 68 percent from the second quarter last year to 60 percent of revenue in the second quarter. Application development and integration and re-engineering services were 40 percent of revenue, representing growth of 51 percent from a year ago. We continue to successfully cross-sell our to development and integration services to our application management customers. And we expect to see continued growth in development and integration in the coming quarters.

In conclusion, Cognizant finished the second quarter with strong momentum. Our pipeline is the strongest it has ever been. New strategic clients are ramping up quickly and we continue to see strong revenue growth from our established customer base. Therefore, we're pleased to increase our guidance. For the third quarter, we now anticipate revenues of at least 94 million and EPS of at least 21 cents. We are also raising our outlook for the full year and now anticipate revenues of at least 354 million and EPS of at least 82 cents.

In his comments Gordon will provide you with more details on our financial performance for the second quarter and our forecast for the third quarter and full year. Now let me turn you over to Gordon.

Thank you, Kumar, and good morning to everyone. I would like to provide some additional information on the second quarter and then discuss our financial expectations for Q3 and beyond in more detail.

Revenue for the second quarter exceeded our prior guidance due to faster than anticipated ramp up of clients we won over the past year or two and a pickup in development spending. Our core businesses remain solid and performed well. Our pipeline is robust. And we're confident in our ability to continue to deliver healthy sequential revenue growth for the remainder of this year.

As Kumar mentioned, application management now represent 60 percent of revenue and application development the remaining 40 percent. Both services grew in the second quarter. On a year-over-year basis, management grew 68 percent and development 51 percent. On a sequential basis, development grew faster than maintenance for the first time in several years. Application management of grew 13 percent sequentially and development and re-engineering grew 25 percent.

All of our key industries grew on a sequential basis. As anticipated, we experienced continued growth in our financial services sector. Financial services, which includes our practices in insurance, banking and transaction processing, grew $5.6 million sequentially and represented 46 percent of revenue in the quarter. Many of the strategic clients won during 2002 were in the financial services sector. The growth of the sector is a result of these accounts ramping up. Health-care grew to $2 million sequentially and was 21 percent of revenue for the quarter. Retail and manufacturing was 15 percent of revenue 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 89 percent of revenue came from clients in North America. This is up slightly from Q1 of this year 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're now starting to see an increasing level of interest for offshore services in Northern Europe. As a result, we would expect the trend to slowly reverse in the future and start to see more revenue coming from Europe.

We added nine new customers during the second quarter. Our active customer base in our core business increased to approximately 110. Four of the clients won during the quarter have the potential to become significant revenue sources for us; three of these clients are in financial services and one is in the retail sector. In addition, we added approximately twenty new clients from the Aces acquisition; five or six of these clients have the characteristics of our core customer base and provide the opportunity to cross-sell our services.

Turning to costs, cost of revenues increased 54 percent for the quarter as compared to the second quarter of last year. 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 2,100 people compared to the second quarter of 2002, and ended quarter with about 6,000 technical staff. This is a net increase of approximately 150 staff from March 31st of this year. In addition, we had a large number of existing staff graduate from our training program during the quarter and become available for build (ph).

Gross margin was 46 percent for the quarter, an increase of 100 basis points compared with our gross margin last year and flat compared to -- I'm sorry -- an increase of 100 basis points compared to our gross margin in the first quarter of this year and flat compared to the second quarter of last year. The sequential increase in gross margin during the quarter was due primarily to a substantial increase in utilization, partially offset by appreciation of the Indian rupe and an increase in our bonus accrual assumptions. We increased our employee bonus accrual to a level in excess of 100 percent due to the substantial increase in our expected financial performance for the year.

SG&A expenses, including depreciation, were 23.1 million, up from 14.3 million in the second quarter of last year. As a percentage of revenues SG&A was 26.4 percent for the second quarter.

During the quarter we continued to strengthen our vertical expertise. We aggressively hired client partners to manage and grow our customer base, a key differentiator for Cognizant, and we opened additional operations in Continental Europe to position ourselves for emerging opportunities in that region.

Operating income for the quarter increased 60 percent to 17.1 million and our operating margin was 19.6 percent, down approximately 10 basis points from the second quarter of last year and up 10 basis points sequentially. During the second quarter we continued our long stated strategy of re-investing any margin above our targeted 19 to 20 percent range back into the business.

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-- 82 cents, up from the 74 cents guidance we provided on our last earnings call. Full year guidance excludes the impact of the nonrecurring expenses we incurred in the first quarter related to the split off exchange offer. We expect the vast majority of our 2003 growth to come from our existing client base, particularly the numerous strategic deals we won in 2002 and the first half of 2003. Based on the feedback we have been receiving from these clients and their intention to leverage the advantages of offshore, we're quite optimistic about the outlook for the remainder of this year and for 2004.

Kumar and I would now like to open the call up for questions. Operator?

(CALLER INSTRUCTIONS)

Julio Quintero (ph), Goldman Sachs.

Real quickly, on the pricing metric, Gordon, can you give us the average rate on-site and offshore real quickly?

Pricing was essentially flat. It was actually up about half a percent to a percent, so we're right around $24 in our offshore and around $68 in our on-site. So up slightly from last quarter.

I am sorry -- can you repeat that one more time? $68 on-site?

Roughly 68 on-site, roughly 24 offshore.

As far as the reinvestment rate is concerned on the SG&A side, can you walk us through what your expectations would be there? Is this sort of a one quarter event or should we expect the reinvestment rate on the SG&A side to be sustained at current levels?

The way to think about it is we're going to reinvest anything above our guided operating range. So, as we have additional dollars available, we will reinvest that into the types of things we're doing now of continuing to strengthen our client partners, building out our infrastructure in Europe, strengthening our vertical expertise. One of the reasons we think we're going faster than the industry is because we're making these investments. So our strategy is to maintain a 19 to 20 percent operating margin and reinvest anything above that.

And the tax rate, obviously it's bouncing around a little bit more than we anticipated. Can you give us some more clarity into what has cause (ph) the changes here?

More than anything else we just got a couple of favorable breaks on things. Some prior year assessments came down in our favor and due to updating our transfer pricing study (ph ) and industry trends on profitability domestically, allowed us to reduce our tax rate a little bit. And as I mentioned, based on what we know now, we would expect to stay at the 20.5 percent, both for the remainder of this year and next year.

Finally, Gordon, EITF-021, any updates on where you are there in terms of how it impacts your business?

For our existing contract base it has virtually no impact. We actually recently did an assessment of if we had been recognizing this under the new rules how big a difference it would be, and it would have been a couple hundred thousand dollars, so essentially nothing.

As we grow, depending on what may happen with large maintenance contracts, that could have an impact, but it's far too early to know that. But based on the type of work we do now, and the type contracts we have now, it does not have an impact.

And how would it impact the maintenance contracts going forward? Is it just the way that you sort of allocate the build versus the manage phases of the contracts?

Remember historically we have not had very large fixed-price, long-term maintenance contracts. And that is the main thing that would be impacted by this, where this combination of development and maintenance -- probably the big maintenance component (ph). Historically we have not have a lot of those because so much of our work has been on a time and material basis and even our fixed-price stuff tended to be fairly short term. If in the future we see a new breed of contracts where it is large long-term maintenance, that could have some impact; but, once again, based on everything we see today, we're not expecting a material impact on any of our existing contracts.

Finally, what is the --

I would stress that there's nothing that we have in the pipeline for the next couple of quarters that will cause us to change anything that we've said so far.

Finally, what is the percentage of revenue that comes from from POC (ph) accounting?

Twenty -- in the quarter 26 percent -- I am sorry -- 26 percent was fixed-price POC versus straight line. I don't have the statistic in front me, but it is probably about 50-50 between the two.

Andrew Steinerman, Bear Stearns.

I'd like to just talk about the type of contracts -- the strategic contracts that we're signing now and what the implications are for future gross margins as they ramp up. I realize that you probably have to offer lower volume discounts to higher volume customers, and is this going to have sort of a mix challenge on gross margin in the coming quarters and even year?

We actually have not -- if anything, prices have firmed up a little bit. So I think that it is really no indication -- and certainly we have not been giving volume discounts that would take prices down significantly. So the pricing I would not say has shown a substantial and strong move upward; but it hasn't move downwards either, despite the larger size of the contracts.

Gordon, the tax rates that is lower now, is that real cash tax savings?

Absolutely, yes.

Adam Frisch, UBS.

Gordon, a little bit on the margins. Can you give us some color on three different areas -- first, the impact of the Aces acquisition -- I think you said in the last quarter that it would be a negative impact of about 50 basis points whether you absorbed them, obviously pretty easily during the quarter; secondly, the bonus accruals in the quarter -- how much did you accrue; and then finally, the areas of SG&A investment? Are you starting to see anything outside of your normal verticals of trends like retail and manufacturing and so forth?

The negative impact of Aces was minimal -- less than we had anticipated. We were able to get the integration done very quickly and we were able to firm up some of their contractual arrangements. So that was not an issue for the quarter.

On gross margin, the additional bonus accrual negatively impacted gross margin by about 90 basis points during the quarter, so we were able to increase gross margin despite also increasing bonus accrual. So we were very pleased --

Did you over-accrue in the quarter?

Absolutely. We accrued at a rate higher than 100 percent, so we accrued extra dollars in the quarter (multiple speakers) so as a year-to-date catch-up.

So as a year-to-date you are ahead of your planed scheduled for bonuses?

Absolutely.

And one final -- the areas of SG&A investment.

As I mentioned, a lot of the dollars right now are going to hiring client partners where probably (ph) we hire a client partner the account grows faster, so it generates both revenue and profits and pays for itself quickly. As I mentioned, we are expanding our footprint in Continental Europe. We hired a senior person at the end of last year and we recently started to open up some additional subsidiaries in Europe. And we also continue to strengthen our vertical expertise and our consulting expertise.

Are you seeing anything in retail and manufacturing (multiple speakers)

In retail, yes; less so in manufacturing, although the financial services and health-care segments still remain the strongest.

Could we actually see pricing start to go up modestly in the next couple of quarters if Europe starts to come through and some of these other verticals start to come through because they're not demanding maybe the same kind of pricing pressure that your more established verticals are, like financial services and so forth?

I'm not sure you'll see average pricing moving up that fast just because the newer contracts will not ramp up for a little while; but I think that the new contracts that we're winning will be at higher prices, because I do see the industry moving to a somewhat tighter supply situation. And if you look at most of the major players, their utilization is up in the 70 to 80 percent range -- up quite a bit in the last couple of the quarters. I've got to believe that's going to lead to higher pricing on contracts. It will take some time before those contracts ramp up and you see those prices reflected in average prices for us or our competitors, so it won't be in the next couple of quarters.

Then final question, Gordon, I was really pleased to hear you say the "at least" part in your guidance. So the upside to '03 is so significant can you offer any kind of initial views on '04 numbers and what kind of -- general views, topline growth, bottom line, what you're expecting here?

Certainly as the year goes on we will provide guidance for '04. Clearly '04 is going to be a good year for us because '04 growth will be driven by the customers that we win in 2002 and 2003 and we've been very successful at winning large strategic accounts. So I think we're going to come into '04 with healthy momentum and a very healthy pipeline of customers already in place to fuel the growth.

So we're not going to get anything quantitative from you?

I think it's too early to do that. I think in the past we have stated that we expect to grow at a rate faster than your offshore industry and (multiple speakers) why we would change that assumption.

I think this year the offshore industry people are estimating grew 20 or 35 percent and we are obviously growing a lot faster than that. I think we will continue to grow faster than the industry. I think in general it will really depend on how strong the industry is. My guess is the industry will grow at least 25 percent next year.

George Price, Legg Mason.

I wanted to follow on the on the pricing comment. Certainly demand seems to be picking back up. But I'd like to maybe explore the other side of that in terms of potential for wage inflation. What are you guys in seeing in terms of wages at this point, and maybe particularly for some of the higher demand areas, such as project managers? And how do you think events such as -- apparently IBM recently has been coming out saying that they're going to focus a lot more on offshore. How do you think that's going to play out in that regard?

So far wage inflation has been pretty contained, but we are keeping a close watch on what's going on. As Gordon mentioned, our turnover did pick up a little bit, which is not unusual right after we pay bonuses. But we want to make sure that that's not a long-term trend. But clearly the industry is, I think, moving to slightly tighter supply situation, and that may have an impact on wages, but it hasn't yet.

Is there -- are you feeling any sort of pressure on-site? Offshore seems to be pretty good. I know your on-site rate is stable, but is there anything happening on-site? Or is that even -- possibly even less pressure that offshore has been recently?

I would say it's about the same time. I don't think there's a bit big difference in terms of price pressure on either side.

The reality is the sophisticated customers don't look at just the on-site or offshore rate, but they look at what is blended rate. So (indiscernible) if one goes up, one goes down. I think the statement about what we see on pricing stability applies to both.

One thing to point out is we have been increasingly selling customers on multi-year programs of cost savings relative to a baseline, rather than trying to focus on rates. So what we are doing is we go in, we do a portfolio analysis of the applications portfolio, and we map out a plan saying, " here's how you take your cost structure down." So the focus shifts away from what's your on-site rate or offshore rate to what savings can we get. So that's helped a little bit as well. Having said that, people still do come back and negotiate rates as well.

And did I -- it sounds like you're not ready to say that pricing is going to move up dramatically in the near term, or at least not in a way that we would see reflected in the numbers. But based on your comments, could we see margins possibly even move up at all, or at least move up into the upper end of the range that you laid out on a sustainable basis?

We manage the business to a 19 to 20 percent operating margin, and they have obviously sort of stayed right in the middle of that range. We expect to stay in that range and we invested -- the key is -- and we invest anything above and beyond that. So I would have the expectations that operating margins are going to stay right around where they are.

Last question, if maybe you could give a little bit of your thoughts on the status of legislation on visas and the whole public perception issue obviously with employment the way it is, getting increased attention. What do clients think? Do they -- obviously the politicians care about this sort of thing, or at least pretend to. Do the clients really care at all about this? Is that a concern? Is that affecting their decision-making at all?

We haven't seen that so far. If anything the demand is stronger than it was six months or a year ago as we look at pipeline. So we certainly haven't seen clients roll down their programs. I think they certainly pay attention to how they manage the change within their organizations, trying to make it as smooth as possible. But beyond that we don't see them making any significant changes. Gordon, you want to talk about the visa?

As you will recall, the cap on H1 visas (ph), which are 65,000 starting in October, our expectation is that that will happen. The burn rate on -- or use of visas is not that different than what the new cap will be, so we don't see any major issues because of that. Various legislation has been introduced on the L1 visa (ph). A lot of it seems to be ending up focusing around the prevailing wage issue. As we have said in the past, we already pay prevailing wage and would support legislation that requires prevailing wage ailing wage on the L1 visa. So it's something we are monitoring. As we become bigger, we are doing more local hiring, and we can do that now because we don't have the utilization issues since we have enough clients in each city. So it is something we're watching, but at this point, based on what we know, we're feeling quite comfortable.

And juts a last thing, could you repeat the net billable adds in the quarter?

Net billable adds increase was 150.

Moshe Katri, SG Cowen.

A couple of questions. Repeat business during the quarter and then the top five clients?

Repeat business was 83 percent revenue. Top five clients was 36 percent of revenue.

I wanted to focus briefly on your bid and proposal pipeline. You have indicated that -- Kumar indicated that is the strongest ever in terms of the size, I guess. Any possibility to quantify how much is it up year-over-year and how much is it up on a sequential basis? And then, looking at your strategic client base, can you give us a feel on some of the average sizes of these -- potential average sizes of these new deals that you're getting on board? Are we seeing an increase in the average revenue contribution from these clients? I think, as you mentioned, it is about -- could be anywhere between 5 to 30. In this pipeline that you're talking about are you seeing larger deals?

I think the answer is relative to a couple of years ago the size of the programs, the nature of the programs in terms of being driven top-down with significant cost savings numbers baked into client budgets, and dealer incentives to managers to implement the program so the nature and centrality, if you like, of the programs has changed significantly. I wouldn't say it's changed over the last few quarters, but if I compare it to a couple of years ago, certainly the deals that we're focusing on tend to have targets of at least $5 million a year, and many of them are actually getting to the higher end of the range of 35 or $30 million a year. One can never be certain when you win one of these deals that they will in fact ramp up, but at this point we have had a very strong track record of doing that and part of that is we have that front end consulting capability and client partners who work with our clients on a multi-year plan, analyzing their application portfolio and talking about which applications they should move first, how much they would save by doing that, providing ideas for rationalizing and consolidating their applications portfolios, further reducing cost that way. So as we start an assignment a client sort of has a roadmap that they tend to follow with us, a roadmap we create and help them implement. So part of it is they have fairly ambitious objectives and part of it is we facilitate those objectives by creating a multi-year plan.

Can you also talk about the bid and proposal pipeline? Anyway to quantify how large -- can you compare that to the last quarter maybe a year ago?

I can't give you a precise number. It's just that the percentage of these larger deals is a lot higher than it used to be. There are a lot of these large deals out there. And also just the sheer number of clients and RFPs (ph) we're getting has gone up quite a bit but I don't have a precise number for you.

Lastly, if you remember during the last quarter one of the most common questions on the call was can you talk about the competitive landscape. I guess there's been concern, and everybody's concerned, and I'm just curious -- do you feel that the concerns over the intensifying competitive landscape was a bit overblown, maybe out of proportion? Again, this quarter we've been hearing some of the comments that are coming in from -- that came in from Infosys (ph) and Wordpro (ph) maybe support that. What is your view on that?

I'm actually less concerned about the Accenture and IBM (ph ) than I was a few quarters ago. I haven't seen them execute as well as I had expected. And although we see them showing up in the final rounds of some of these RFB competitions, that their win rate has been relatively low, I would say. I am certainly not discussing guys (ph) longer-term, but obviously the longer they delay in ramping up their capabilities, the bigger the gap becomes relative to Cognizant or emphasis (indiscernible) is going to be for them to catch up. So to some extent I'm less concerned than I was a couple of quarters ago.

Last question, you typically will give us them mix of available headcount offshore versus on-site. Did it stay the same -- like 70-30? Any change there?

It stayed right where it was last quarter -- around 70 percent offshore and 30 percent on-site.

Pat Perkin (ph), Smith Barney.

I guess I will ask a couple of strategy questions. The first will on BPO (ph) -- any of new thoughts there as to where you stand entering some of those markets, perhaps with minority investments? And the second question would be given your tremendous cash generation capabilities is there any thought of maybe initiating a very small dividend?

On the BPOI front our objective really is very much to enter the space, but not going to -- as I think we've mentioned many times before -- not to go into the sort of the commodity call center space. The good news is the longer we wait, the lower the asset prices become. So it helps because there is intense competition in the space and in the margins of the folks who are playing in the commodity call center and they have not been very good.

However, there is continued very strong demand from our clients who say to us that since we're maintaining the technology that runs many of their business processes, and understand how to improved those business processes it makes -- using technology it makes a lot of sense for us to take over the entire process. So at this point we are trying to select which areas we want to play in and working with a bunch of clients to try and do that. We may also make, as we have mentioned before, a minority investment on an acquisition on a small operation in India to just get us started, but again trying to avoid getting into the commodity call center business.

The question of cash, as we're competing in larger and larger deals and succeeding in these deals, one of the things that is very helpful to us is having a rock solid balance sheet because customers want to know if they're going to do hundreds or maybe even a thousand people offshore with us that we're going to be around for the long-term. So I would expect that we would want to continue to strengthen our balance sheet in the near-term.

Joseph Vafi, Jefferies & Co.

Kumar, can you talk a little bit on your views if we look into calendar year '04 -- obviously you're going to have to give your people some wage and salary increases for next year -- your ability to maybe pass some of that increased cost on to customers across your current book of business?

That is an issue we're obviously working on. I think it should be pretty good, but it -- we really won't know about what sort of pricing increases we'll get next year until -- most of that tends to happen in the latter half -- in the last quarter of the year and the first quarter of the new year. But in some cases we do have price escalation built-in to the contracts; in some cases we don't and will need to negotiate them. But at this point we have very little concern about our ability to maintain the operating margins going into next year. The only wild-card, as always, is the rupe and the currency rates, which again we can absorb. I would say a significant move, but it's a move really got out of hand, and clearly there would be a period in which margins would shrink while we tried to renegotiate prices to offset that. But barring that sort of a very unexpected and very large move in currencies, we think we should be fine on the margin line.

On the development and integration business, a little more caller on the uptick. Is that coming -- the growth there, is that coming from current customers on the maintenance side spilling over into development and integration projects? Or is that kind of -- is growth being driven there on its own?

(indiscernible) it is cross-selling to existing clients and for the first time we are seeing fairly large project being started, which is -- we haven't seen for years, really. And we've gotten a couple of projects which will be in the $10 million range and that has helped in picking up the growth rate there.

And thne finally, if you look back a year ago at the business versus today, and you look at some of the new maintenance customers that you're signing, what's the change, if any, in the kind of ramp timeline that you have seen for new customers that you are signing today versus customers you signed a year ago?

I'm not sure there's a big difference from a year ago, but if you compare it to three of four years ago there's a huge difference. The strategic clients are ramping up to whatever their target is -- whether it's 5 million or 10 million or 15 million -- certainly within a few quarters or a year, whereas that sort of ramp up probably took a couple of years or longer, if you went back four or five years. In the last year I'm not sure there has been a huge change, if you're thinking of 2002 and 2003.

Would we expect that ramp to shorten any from where it is now then or are we kind of at a steady state in terms of --

I think we're sort of moving extremely fast on many of these clients. I'm not sure it's going to grow that much faster than it is now, but hopefully the current rates will continue.

Ed Caso (ph), Wachovia Securities.

I had a question on are you seen the independent consultants, the contract consultants like GPI (ph), are they becoming a bigger part of your new business machine? And how has that changed and how do you see that change going forward?

I would say they are they in a small number of contract, yes. I think you may be right that their influence may increase. I think as they see less of the sort of very large mega-contracts on which they were working before, they're certainly trying to establish their credentials in the offshore space and the application outsourcing space in these contracts. But so far it's been on a minority -- just a handful of contracts.

And I missed the turnover -- billable turnover numbers. Could you repeat them?

Total turnover for the quarter was 14 percent. That was both voluntary and involuntary and about half of it was people voluntarily going to other companies. That is annualized.

Just a clarification on the comments on Accenture and EDS and so forth. Have they started to go outside their existing client base yet or are they still focused on protecting their existing clients?

By and large I think they are -- I have seen them winning -- it's been with their existing client base where they have built a system or have a very strong relationship existing -- pre-existing relationship. We haven't seen them winning in the sort of large open RFP situations where clients really make econo (ph) devaluation of the offshore capabilities of the vendors and compare them on that basis.

So the -- and the pricing -- are they coming in to the -- is Accenture going -- are they going after deals that are not there as in not winning them (ph) or are they just not going after existing client deals?

We do see them in some deals, which -- I guess Accenture -- it depends on what you mean by an existing client. They have worked -- done some work in almost every client at some point. But where I see them winning is where they have really strong current relationships. But they do participate more broadly than that. We have seen them sublet (ph) RFPs in many of the more open situations where they don't currently have relationships which are as strong.

Do you see any suicide pricing or crazy pricing by some of the second and third tier players or have they fallen in line?

The second and third tier players still are pricing significantly below Infosys (ph), Quickpro (ph) and Cognizant, I would say by 15 to 20 percent. But again, despite that, the bulk of the business seems to be going to these three companies and Tardus (ph) to some extent.

Mayank Tandon, Janney Montgomery Scott.

Just a couple of questions here. One, could you talk about package implementation? Some of your peers have been investing in areas like that. Also, you guys did with the Aces acquisition. Is that work offshoreable (ph) at this point? How do you see it playing out?

We're focusing more on ongoing application management and upgrades than on implementation, although we also do -- when you say implementation if you take Siebel, for example, Siebel consistes of numerous modules (ph), so they often will add data -- an analytics module and set up the analytics capabilities. If you call that implementation, then, yes, we do some implementation. We're rarely go into a situation where a client has never used Siebel before and implement a totally new system because that tends to be much more on-site-centric. But for the sort of work we do, we actually achieve offshore ratios in the 6 to 7 percent range.

Over time do you see packaging limitation going sort of more offshore-centric?

Absolutely. If I look at the pipeline, one of the strongest things we see right now is package application management, package upgrade, that whole set of activities -- and consolidation. Very often people have -- one large banking client right now has nine or ten different instances and versions of SAP running around the world that they want consolidated down to a single version in a small number of data centers. That sort of project is a big part of what we see in the pipeline.

I would think that is the kind of work that is more the domain of players like Accenture and IBM, or still is, and that's where you would be competing head-to-head with them?

Yes, I guess so, although I think for that sort of work the clients who have large offshore relationships tend to use their offshore players to do that sort of work now.

Longer-term, how do you the BPO sector playing out? Will it be bundled with IT or do see it being sold separately? What are your sense of sort of the long-term report for the client?

BPO is such a large market and has so many pieces to it, it's really extremely hard to generalize. I think one would have to test that BPO -- if the BPO market in the five, six, maybe ten times as large as the IT services market. So our strategy really is to focus on those pieces of the BPO market that are closely related to what we do in IT. So we're picking the same vertical segments and in the processes that we entirely understand through our IT work and where we know the technology and can actually get process advantage and cost advantage through our knowledge of IT. So in those areas I think the two will start to get bundled together. Clients will say, "hey, you know, if you are maintaining our claims processing system, help us do the claims as well." I see less connection with some of the stuff that's currently happening in India with many of the BPO companies which seems to have very little connection with the IT side of the business.

One question on the wage rates. Infosys (indiscernible) I think talked about a one to two percent increase last quarter. I guess I get the feeling that you guys didn't raise wages this quarter. Is that fair to say?

No, we increased wages in April, pretty much in line with what are key competitors did. So there were increases. They're part of the Q2 numbers.

I guess we probably have time for one more question.

Ashish Thadhani, Breen Murray & Company.

I'm just trying to get a better handle on jow broad-based the growth has been. How many clients do you have that fall into the strategic category of 5 to 30 million compared with a year ago?

Last year we won 16; we won 3 in the first quarter and 4 in the second of this year, so compared to the beginning of 2002 we've added 23. Prior 2002 we've probably only had 6. So almost all of the strategic clients we've won in the last 18 months.

And the salary hike, is that an annual exercise?

Generally we will do an annual salary increase.

You just indicated that you don't expect an immediate gross margin impact, right?

We've already done some increase for this year.

The big increase for this year was part of the Q2 numbers.

In closing, let me say that our pipeline has never been stronger and we expect that a strong growth will continue. We also expect our operating margins to be stable in the 19 to 20 percent range.

I'd like to thank our talented employees for delivering outstanding service to our clients and driving our strong growth. I would also like to thank the analyst community and our shareholders for their continued confidence and support. We look forward to updating you all again in our third quarter call.

(CONFERENCE CALL CONCLUDED)