高知特 (CTSH) 2004 Q1 法說會逐字稿

At this time I would like to welcome everyone to the Cognizant Technologies first quarter earnings conference call. (OPERATOR INSTRUCTIONS) Mr. Smith, you may begin your conference.

Thank you and good morning everyone. By now you should have received a copy of the company's first quarter earnings release. If not, please call Kelly Cunningham (ph) at Financial Dynamics at 212-850-5600.

On the call today we have Lakshmi Narayanan, President and COO of Cognizant Technology Solutions, and Gordon Coburn, Chief Financial Officer.

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 Lakshmi. Lakshmi, please go ahead.

Good morning everyone and thank you for joining us for Cognizant's first quarter 2004 earnings call. We're pleased to report another strong quarter in which Cognizant delivered better-than-expected financial and operating performance. We have maintained and built on our industry-leading growth trade, supported by our strategic solutions offering, our high quality employees, solid execution and undeniably strong customer satisfaction. We also continued to strengthen our position as a highly differentiated PO1 (ph) provider of offshore outsourcing services, and this is reflected in our ongoing ability to broaden and deepen our relationships with existing clients, as well as maintaining a high win rate against our competitors.

We ended the quarter with sales of $119.7 million, up 11 percent sequentially when compared with the 108.2 million in fourth quarter of 2003 and up 61 percent (ph) from the first quarter of 2003. Earnings per diluted share were 28 cents compared to 25 for the fourth quarter of 2003.

We remain very optimistic about our growth opportunities for the remainder of 2004 and believe that Cognizant is well positioned for continued strong momentum in the offshore outsourcing market. Furthermore, we continue to grow faster than the industry due to our industry-leading fourth generation business model and strong focus on execution.

During the quarter we added a total of 44 clients to our growing list of premier clients, 21 of which came through the acquisition of Ygyan Consulting. We were selected as the offshore partner in three accounts which we consider to be strategic. As a reminder, we define strategic clients as those that have the potential to eventually generate 5 to $40 million or more in annual revenues for Cognizant. Cognizant now has approximately 40 strategic clients.

Our operating margins remained stable in the 19 to 20 percent range, and we're confident that it will remain at these levels due to the leverage of our cost structure. This is due in large part to a strategic prior investment at much higher rates than our competition in sales and marketing, allowing our current management costs to be lower for the new and larger relationships than in the past. Additionally, I'm pleased to report that pricing remained stable due to solid demand from new and long-term clients.

Regarding our staffing, we added more than 1,200 associates during the quarter, closing the quarter with approximately 10,500 associates. We continued to expand with plans to finish 2004 with more than 13,000 employees. Additionally, annualized employee turnover was down to just 10 percent during the quarter. Our staff continues to be an important differentiator for us, and as a multinational company it is our ability to attract and retain local talent in our strategic markets that is a major reason for our continuing success. Based on this high level of interest in Cognizant as an employer of choice and consistently highly qualified candidates we continue to attract, we are confident in our ability to recruit and retain the most qualified people to maintain our strong competitive position.

To satisfy the strong demand that we continue to experience we previously announced building plans for building or expanding three fully-owned techno (ph) complexes with over 600,000 square feet of office space for 6,500 hundred employees. We're happy to report that our construction plans are on track. We plan to spend slightly over $40 million during next two years on this construction program, and once fully utilized these additional facilities are expected to generate substantial annual operating expense savings compared to the expanded use of leased facilities.

I would now like to spend a moment or two talking about another one of Cognizant's key differentiators. This quarter has seen us reach new levels of what we call customer intimacy in terms of the depth, breadth and efficacy of our relationships with our clients. We recently conducted a customer satisfaction survey which had a record response rate and showed that satisfaction among Cognizant clients remains very high. To give you some insight into the survey we received the highest scores for responsiveness to business needs, flexibility in managing change and technical competency. The results also show that customers credit Cognizant's ability to deliver industry-leading cost effective solutions and resources.

Cognizant was also recently profiled in a Forrester report that placed us in the leader category on the basis of our strong relationship management skills. The report indicates that many potential customers need to (ph) differentiate between the leading Indian suppliers and that one of the most significant differences, and therefore key selling points, for Cognizant is the relationship management philosophy by which customers are engaged. Our strong relationship management philosophy clearly separates Cognizant from the pack. The report references our high customer satisfaction and reputation for flexibility among our clients, and also our excellent customer relationship disciplines, including Cognizant's pioneering use of American nationals for key customer relationship roles in North America.

Clearly we're proud of this recognition and believe that the effectiveness of these differentiators is evidenced by a track of our (ph) continual strong financial results.

Turning to our mix of services, for the fourth quarter in a row application development and integration continued to grow faster than applications management at the sequential rate of 14 percent compared with the overall revenue growth of 11 percent. This growth and development emphasizes our success in executing large and complex programs as a part of our transforming while performing approach. Clients initially choose to work with us because of our deep expertise and extensive project management experience and our reputation for high-quality and fast turnaround. It's our quality of work, solid execution and follow-through that provides such a strong foundation for effectively cross selling our services. This is amply demonstrated by the fact that more than 85 percent of revenue in the quarter was from retained clients who have worked with Cognizant for at least one year.

To give you a little more color on the potential for our change management and technology consulting business and some of our higher value added activities, we recently announced results from a new study that showed that on average 12 percent of business software applications in most large enterprises are redundant and can be either consolidated or eliminated. The study also shows that our customers have reduced their IT maintenance costs by a sustained 30 to 40 percent after using our portfolio analysis service and leveraging Cognizant's offshore capabilities. Clients saved an average of 12 percent, even before moving applications management offshore, by working with us to develop and implement a strategy for streamlining their systems. Cognizant helps clients gain a clear understanding of which software applications are critical to their businesses, how those systems can be enhanced and what it costs to run key systems over the long-term.

With companies looking to run IT as efficiently as possible they are increasingly turning to Cognizant to provide analysis and strategic recommendations that will enhance their operational performance over the longer term. Our business and technology consulting practice meets that need, and combined with our expertise in application management and development Cognizant can effectively advise clients on how to get bottom-line results using the most effective IT investment and operation strategies.

It's also clear that our investment in the strategic vertical approach to the market is paying off. We continue to see strong growth across our key vertical markets, with particular strength in the financial services and insurance. To give you some color on the geographic trends that we see, we have continued to gain momentum in the UK and in continental Europe where we've seen demand from the financial services sector, in particular where clients seek to leverage offshore benefits for applications development project. Additionally, we've seen a general increase in interest in offshore outsourcing in this region and we are receiving an increasing number of inquiries from potential clients. As we've mentioned in a previous call, we began working with global clients in Japan and China during 2003, and we're currently in the process of setting up a small office in China to meet client needs. We have the ability to work with our global customers to meet their growing needs around the world.

As you will recall, we recently acquired Ygyan Consulting, a Pune, India based SAP services provider. Cognizant has seen increased demand from our customers for many SAP services, including upgrading and enhancing their SAP applications and ongoing maintenance and support. The Ygyan acquisition helps us meet customer needs and increase our SAP capabilities. Ygyan has 85 primarily offshore consultants in the SAP practice offering, offering the entire range of services and will enhance Cognizant ability to deliver offshore application management projects, large implementation projects, SAP version upgrades and ABAB development projects. Ygyan also has expertise in all SAP modules including the business warehouse and Sierra. This small acquisition allows Cognizant to better serve customers with their SAP needs and is in keeping with our strategy of focusing on tuck-in acquisitions which can give us access to a client base, specific expertise on knowledge of local markets and applications to spearhead our expansion strategy.

In closing, I'm pleased to report that Cognizant is off to a strong start in 2004, turning in a solid performance across our entire business. Our pipeline of new business remains very strong and we continue to see an increasing number of visits from prospects and customers. We continue to solidify our position as a highly differentiated premium provider of offshore outsourcing services and demonstrate to clients the significant value of working with our organization. We expect this solid momentum to continue and reiterate our expectation to be able to grow the business faster than the industry growth rate.

I would now like to turn the call over to Gordon for a more detailed look into the financial performance and guidance going forward, and then we will be happy to take your questions.

Thank you Lakshmi and good morning to everyone. I'd like to provide some additional information on the first quarter and then discuss our financial expectations for the second quarter and full year.

Revenue for the first quarter substantially exceeded our prior guidance due to continued application management ramp up of clients won over the past few years and continued greater than anticipated strength in discretionary development spending, a trend that started for us in the second quarter of last year. Revenue grew 11 percent sequentially and 61 percent year-over-year. Our core businesses remained solid and performed well, our pipeline is robust and we're confident in our ability to deliver healthy sequential growth in 2004.

For the quarter application management represented 56 percent of revenue and application development integration the remaining 44 percent. Both services grew in Q1. On a year-over-year basis application management grew 40 percent and application development and reengineering grew 88 percent. On a sequential basis development grew faster than maintenance for the fourth quarter in a row. As Lakshmi mentioned, application management grew 9 percent sequentially and application development and reengineering grew 14 percent.

The largest drivers of growth in the first quarter were financial services, which includes our practices in insurance, banking and transaction processing. It grew $9 million sequentially and represented and represented 51 percent of revenue for the quarter. Health-care grew $0.5 million sequentially and was 19 percent of revenue. Retail and manufacturing grew about 2.5 million sequentially and increased to 16 percent of revenues. And information services was 7 percent. The remainder of our revenues came primarily from other service oriented industries, as well as our alliances.

During the quarter 87 percent of revenue came from clients in North America. We're now starting to see increased interest level in northern Europe for offshore services, both from European divisions of our global clients, as well as from an increasing number of local clients. European revenue was 12 percent of the total in the first quarter, up from 11 percent last quarter.

We added 23 new customers during the first quarter in our core business, up from 16 last quarter. In addition, we added 21 customers through the Q1 acquisition of Ygyan. Our active customer base increased to 193. During the quarter we were selected as the offshore partner in three accounts which we consider to be strategic. We ended work for four clients during the quarter.

Turning to costs, cost of revenues increased 59 percent for the quarter as compared to the first quarter of 2003. 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 approximately 1,200 during the quarter and ended the quarter with over 9,600 technical staff. This is a net increase of over 3,800 from the staff in Q1 of 2003.

Gross margin was 45.7 percent, a decreased of 10 basis points compared to the fourth quarter of 2003 and an increase of 70 basis points compared with the first quarter of last year. Compared to the fourth quarter of 2003 gross margin was negatively impacted by compensation increases implemented in India in January, partially offset by savings in variable compensation compared to the fourth quarter of last year. However, during the first quarter we were pleased to once again accrue bonuses at a level above 100 percent in anticipation of sharing this year's success with our employees.

SG&A expenses including depreciation were $31 million, up from 19 million in the first quarter of last year. As a percentage of revenues SG&A was 25.9 percent for the quarter, down 10 basis points compared to the fourth quarter of last year.

During the quarter we continued strengthen our vertical expertise and we aggressively hired client partners to manage and grow our customer base, a key differentiator for Cognizant. In addition we further expanded operations in Europe to position ourselves for the emerging opportunities in that region, and we invested in building out our managed services capabilities.

Operating income for the quarter increased 63 percent to 23.7 million from 14.5 million in the first quarter of last year. And our operating margin was 19.8 percent, flat sequentially and up approximately 30 basis points compared to the first quarter of last year. During the quarter we continued our long stated strategy of reinvesting any margin above 20 percent back into the business.

Interest income for the first quarter increased to $840,000. Interest income increased due to higher global cash balances and an increased balance of European currencies which are at slightly higher interest rates.

We had a $300,000 foreign exchange gain during the quarter, resulting primarily from the impact of the appreciation in Indian rupee on our net monetary rupee assets in India.

Our tax rate was 20.3 percent for the quarter. We expect our 2004 rate to remain at this level.

Turning to the balance sheet, our balance sheet remained healthy. We finished the first quarter with almost 200 million of cash and bank deposits, an increase of approximately $5 million compared to last quarter. Q1 cash flow was impacted by the increase in DSO, which I will discuss in a minute, and the seasonality of bonus payments.

During the first quarter operating activities generated 2.8 million of cash. Operating cash flow for the quarter was negatively impacted by an increase in trade receivables from an unusually low level at the end of 2003 and the pay-out during the quarter on a significant portion of 2003 bonuses. Financing activities, primarily the exercise of stock options, generated $4.5 million. These amounts were partially offset by 2.7 million of capital expenditures, including expenditures for our Indian construction program and a net cost of $1.5 million for the acquisition of Indian-based Ygyan which strengthened our SAP capabilities. In addition we generated $1.5 million from currency translation adjustments, primarily the strengthening of the British pound.

Our collection of trade receivables during the quarter was weaker than in prior quarters. Based on our $84 million balance at March 31st, we finished the quarter with a DSO including unbilled receivables of 64 days, slightly above our historic levels and significantly above our level at the end of 2003 which was unusually low and as we discussed on our Q4 call was unsustainable. Excluding unbilled receivables our DSO was 54 days for the quarter.

The increase in DSO resulted primarily from two factors -- a high percentage of the quarter's billing days that occurred in the month of March; and the delay to the latter part of the quarter in invoicing January and February work due to the need to complete new purchase orders for 2004 for certain clients. Those purchase orders have been completed. We do not expect these factors to reoccur in the second quarter, and therefore would expect DSOs to decline from the March 31st levels.

The quality of our receivables portfolio remains exceptionally strong. Of our total AR balance only approximately 6 percent is over 90 days old. Our unbilled receivable balance was 12.7 million at the end of the first quarter, up approximately $3 million from December 2003. The increase in unbilled receivables resulted from several factors, including the timing of milestone depletion on several large projects and volume associated with our sequential growth. Once again, a very significant portion of our unbilled receivables balance is being billed in the month of April; approximately 65 percent of the March balance will be billed this month.

During the first quarter over 23 percent of our revenue came from fixed-price contracts, down from 27 percent in the fourth quarter of 2003 and flat with the first quarter of last year. When we look at the mix by solution type during the quarter, 30 percent of our development revenue and 18 percent of our maintenance revenue came from fixed-price contracts.

Turning to headcount, at the end of the first quarter our worldwide headcount including both technical professionals and support staff total 10,490. This represents a net increase of approximately 1,250 people during the quarter. Approximately 60 percent of these net additions were recent college graduates who will enter our training program and the remainder were lateral hires of experienced IT professionals. As previously indicated, we expect to finish 2004 with more than 13,000 employees globally, a majority of the 2004 additions being recent college graduates who will participate in our entry-level training program.

As Lakshmi mentioned, turnover including both voluntary and involuntary was approximately 10 percent annualized during the first quarter. Approximately 90 percent of Cognizant's turnover occurs in India, resulting in on-site annualized attrition rates well under five percent. In addition, the attrition is heavily weighted towards the most junior members of our staff. Going forward we continue to target an attrition rate in the low teens, in line with our historic levels.

On-site utilization was just below 90 percent for the quarter. Offshore utilization, excluding recent college graduates who are in our training program during the quarter, was essentially flat at 75 percent. Including trainees, offshore utilization was approximately 60 percent during the quarter. We had over 1,300 people in our non-billable training program at the end of the quarter.

Now I'd like to comment on our growth expectations for the second quarter of 2004 and for the full year.

We're comfortable with our ability to deliver revenue in the second quarter of at least 128 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 second quarter revenue guidance. For the full year 2004, based on the strong demand environment for offshore services and our favorable experience on ramp up rates, we now expect revenue of at least $530 million. As has been typical in prior years, we expect the majority of our growth in 2004 will come from the ramp up of clients won over the past few years.

During 2004 we intend to continue to closely monitor our spending and expect our operating margin to remain in the 19 to 20 percent range, in line with our historic margin level 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 approximately 29 cents for Q2. This guidance includes an anticipation of a Q2 share account of slightly less than 72 million shares, a tax rate of 20.3 percent rate and the absence of further non-operating foreign exchange gains or losses.

As you know, we recently announced our intention to complete a two-for-one stock split later this quarter, subject to shareholder approval, of an increase in our authorized capital shares. We would expect our post split EPS to translate to approximately 14 cents for Q2.

Based on our current business trends, we currently expect EPS for the full year to be at least $1.19. This guidance includes the anticipation of a full year share account of approximately 72.2 million shares. In addition, this guidance assumes a tax rate of 20.3 percent and the absence of further non-operating foreign exchange gains or losses. We would expect our post-split EPS to translate to at least 59 cents for the full year.

We expect the vast majority of our Q2 and 2004 growth to come from existing clients, particularly the numerous strategic deals we have won during the past few years. Based on the feedback we've been receiving from these clients about their intention to leverage the advantages of offshore, combined with the strongest pipeline in our history, we are quite optimistic about the outlook for the remainder of this year and believe we're exceptionally well positioned for success in 2004.

Now Lakshmi and I would like to open the call for questions.

(OPERATOR INSTRUCTIONS) Adam Frisch, UBS.

A couple of dimensions (ph). I know they're strong all over the place, but could you touch on a few things here that may not be directly reflected in the numbers necessarily, like client visits? Political backlash with was not something you mentioned in your prepared comments. Also, maybe the buying environment, sales cycles, deal size, types of customers, things like that, that would kind of give us some color around the numbers that continue to exceed?

In terms of the client research (ph), what we noted in the last quarter was the continuing trend of visitors visiting India to evaluate various vendors. That's continuing. The pipeline, as Gordon indicated, continues to be strong. There's a whole lot of valuation that is going on at this point in time.

In terms of the backlash and the --

Can I go back just before you move on to that one? In terms of client visits, companies are still obviously coming over a lot, but are they bringing more people; are they bringing more senior people; are they faster on the trigger, so to speak, in terms of signing up with you guys?

The difference between let's say six months back and now is very, very focused visits. The key decision-makers visit, spend no more than two or three days in India, visit two or three of the partners that they have already short-listed, talk business and then get back and announce the results of that evaluation. That is the way it is. It's not exploratory. It a lot more evaluation and decision-making. And the profile of the people visiting is also increasing. More and more senior people are coming.

As far as the backlash is concerned, while there is a lot of talk about in the media many of the customers and prospects that visit, it is not a serious concern for them. Many of these people have decided on this type of an outsourcing program utilizing the global delivery model, so to that extent much less concerned from their perspective about the backlash. There is a certain program that they have announced prior to making the research and they continue on that path.

Even from the existing customers that we work with, while there is not much of a discussion that's going on in the open as to what type of work is going on, what type of projects are being outsourced, but the momentum is continuing. We haven't come across any situation where there's a pull back on behalf of the customers or any of the delays in the prior previously announced programs.

And then just the buying environment. I think you kind of touched on that with the client visits, but like sales cycles, deal size, things like that.

Right. The strategic customers typically want to pick a partner that they want to work with and try and source as many solutions, as many offerings from that particular vendor, which is a very important point for us because the reason why we are very particular about the customer intimacy and the relationship model is once you have the relationship built with our customers you have earned that trusted partner, trusted advisor type of status. Then you can go under that umbrella and sell more and more of the services -- it could be business and technology consulting (inaudible).

So increasingly people are looking at the broad range of services within the application development maintenance program, not just a pure package implementation or post-package program. And there are instances where customers are looking since they visit India -- particularly when they are visiting -- they look at both the IT capability, as well as the business processing outsourcing capability, although there is -- there's no decision many of the people want to launch the IT program first, but to evaluate the BPO options as well. We see that as a trend from some of the more recent pipeline opportunities.

In terms of the cycle, extra (ph) sales cycle, it's pretty much the same. I wouldn't say that it has come down significantly. However, the focus and the precision with which the entire process is being carried out has improved tremendously over the last six to eight months.

Great. Thanks for that. Turning to people for a second, 13,000 by the end of the year, I'm assuming that is total. If we assume about another -- about the same ratio -- about 8 percent -- is admin and the rest is billable that is a headcount add of a little over 40 percent. Is that about right, Gordon?

Yes, that's correct. Once again, note that we said at least 13,000.

So if it stayed at 13,000 and n your headcount was up 40 percent, are there increases in the utilization that you expect? Or do you think it's going to remain around 75 percent for offshore excluding the trainees?

Excluding trainees around 75 percent, but obviously there's a big -- there are a lot of trainees in the system right now. As I mentioned, there are 1,300 people in training right now.

Could the utilization excluding the trainees move up or do you want to kind of keep it around 75?

Excluding trainees around 75 percent is right. Including trainees that number could bounce around.

Sure, from quarter-to-quarter. Understood. Last question on margin impacts. Gordon, I noticed in your comments you said you did spend some SG&A to keep margins in that 19 to 20 percent range. It is safe to say that the rupee appreciation is manageable here? And can you also talk about what your expectations are for pricing and wage inflation going forward?

Let me start with the rupee. The rupee appreciation had virtually no impact on Q1 numbers because obviously we use the average rates for the quarter for translating salaries. It did generate, though, that FX gain below the line.

Based on today's FX rate compared to our average for last quarter the rupee is up about 2.5 present, which costs us in isolation about 50 basis points. We're very comfortable being able to handle that in our margins. We have a lot of leverage in SG&A. As we continue to hire the college graduates that flattens out our pyramid a little bit. So at current levels we fully understand how we would handle the rupee appreciation.

Pricing, as Lakshmi mentioned, remains very strong. New deals are going off at higher rates than deals did a year ago. That partially gets offset by the business is shifting towards larger customers who generally have a little bit lower billing rates. But overall realized rates are very stable. So we're comfortable with that.

In terms of wage inflation, the big increases went into effect in January, so that was already in our Q1 numbers. There will be some raises associated with promotions and so forth this quarter, but the big number hit us already in January.

Great. Thanks a lot guys.

Joseph Vafi, Jefferies.

Great results again. I was wondering if we could kind of drill down a little bit more into some of the applications development growth. Obviously part of that is probably just some rebound off some levels that might have been a little depressed a year ago. But maybe some color into kind of some of the activity going on in the corporate IT department. Is the growth coming from more larger project kick off at this point or would you attribute it to kind of just a higher level of activity going on in the customers' IT department and that kind of trickling into your business?

It's more of the latter. It is an increased level of activity in the IT divisions of our customers where the discretionary spending that they have, they are opening up the purse strings. And there are some new initiatives that are weighed largely towards larger projects. These are some strategic projects that would support the new revenue streams that the client organizations are chasing.

Broadly take a look at it there are two categories in which the customers spend the money. One is in terms of refurbishing the old technology into new technology. That means sun-setting the old applications and creating new applications. That's one set of activity which is slightly lower compared to entirely new initiatives where this is a new application, a new product that is being developed in order to offer a different product or service to their customers. The level of investment in that appears to be a little higher than the reengineering type of work, plus they tend to be complex projects so the ability to manage them effectively is a key requirement in order to succeed in those projects.

And if we could drill down a little bit more into some of the SAP business and maybe into the consulting business, sounds like the lead offerings in the consulting business are still, let's call them kind of cost-saving initiatives for customers, and kind of, Lakshmi, what you might be thinking about the business moving forward as your model continues to evolve, maybe leading more with consulting offerings that move beyond just kind of cost savings into other areas of the IT department or other initiatives that IT professionals might be interested in?

That is right. At this point in time let me talk briefly about the business and the technology consulting offering that we have.

There are broadly two types of service offerings that we have there -- one is how to manage the changes associated with this offshore outsourcing; and two, how to get the maximum returns on the IT investments that our clients are making. These are what we call the portfolio rationalization and also the business optimization through technology rationalization. These are the two significant offerings that customers find significant benefit in.

What it does is when the customers decided strategically to do this outsourcing we advise them as to what's the best way to go about doing it, what are the solutions that we can offer a vendor and how we can focus this over a multi-year period of time. That's the consulting offering, and like you rightly said it is focused at this point in time more towards the cost reduction in than towards new revenue generation.

The next initiative was part of this BTC -- the business and technology consulting -- used to provide domain expertise in order to look at revenue generation opportunities through the application of technology in the business. So that's the follow on offering.

Likewise, in the SAP area, the specific thing that we're focused on are the post-implementation activities. Many of the customers have implemented large packages -- SAP CRM packages -- and they have to work in an integrated manner with the other software and technology that they have within the client organization.

So we step in and provide that integration, as well as the post-implementation maintenance from our offshore facilities at a lower cost. So these are, if you like -- and I talked about building a relationship with the customers and then offer additional follow on upscale solutions like SAP implementation, post-implementation support, consulting and so on and so forth.

We see a good traction in the technology consulting and the business consulting area where clients want to transform from the old to the new at the lowest cost, and that's where we seem to be winning as an entry strategy. This consulting offering is both to our existing customers, as well as we've taken it as a lead offering for the newer opportunities where that's the first thing that we carry out before deciding a long-term program for the customer.

Fair enough. Maybe one more questions that might be interesting here is I know the company has continually reinvested the extra -- let's call it the extra margin about 20 percent into the business. If we look back a year at what the Company might been spending the excess profit on a year ago versus today, has that changed at all in the types of investment that you're doing at this point?

It's broadly pretty much the same, except that I'll give some indications of one or two types of activities that we're currently pursuing. The level of business analysts (indiscernible) from leading universities that we hire in India, that has stepped up. That is something that we've increased. In addition, there is a program that we've launched whereby we're hiring MBAs from the top schools in the US -- all 15 of them -- take them to India, put them through the entire process of this on-site offshore model, get them to work in specific projects in India for about between six months to a year, bring them back and get them to work with both the business and technology consulting group, as well as with our relationship group so that we can provide higher value added services to our customers. This requires a certain amount of investment, and that's the additional type of activity that we're investing in which we did not do about a year back.

We continue to invest heavily in what we refer to as client partners. These are the on-site based relationship managers. And we think one of the reasons we're growing faster than any of the other major players is because of this investment in business analysts and on-site relationship managers. Customers consistently tell us it's a way that Cognizant differentiates itself and is one of the reasons we think we're growing faster.

Finally, Gordon, excluding some of the acquisition activity do you have a figure for the organic revenue growth in the quarter?

The only acquisition during the quarter was Ygyan, and given it closed late in the quarter it only contributed about 200,000 of revenue for the quarter. Asis is so integrated to the business at this point you can't really break it out anymore because it's fully integrated. Infopulse was ballpark at $1 million or so quarterly run rate.

Great. Thanks a lot guys.

Julio Cuanteros, Goldman Sachs.

Real quickly, can you just run through those numbers again? I'm sorry. I just wanted to get the acquisition contributions one more time.

Ygyan closed very late in the quarter late in the quarter. It generated about 200,000 of revenue. Asis you can no longer separate. And Infopulse is a business when we acquired it ballpark runs at about a $1 million quarterly run rate.

Great. As far as the -- can you talk a little bit about your operating cash flow expectations now? Looking at the model that I had prior to today we were still looking for about 100, 108 million or so in operating cash flow and about 68 million in free cash. I know you don't give specific guidance, but can you talk to what the trajectory for cash flow looks like for the remainder of the year and how you expect to recover from this quarter's result?

Sure. If you look at this quarter two things happened. One is a big increase in DSO. As we mention, I don't think it's going back to the 52 day level which was an anomaly, but I certainly would expect based on what I'm seeing at this point that it will drop from the 64 days we're at. And Q1, we accrued a very high level of bonuses last year and the vast majority of that was paid out in Q1. So both of those things had a big impact on Q1 cash flow. So we certainly expect Q2, Q3 and Q4 cash flow to sort of be back in line with sort of what people would normally expect. We don't give specific cash flow guidance for the year, but I certainly would not look at Q1 as indicating a less favorable trend for the year.

Is it safe to assume then that operating cash flow for the year should grow at least in line with your net income growth or revenue growth maybe? (multiple speakers)

Ballpark in line with net income. DSO could move it a little bit, though. But at a real macro level in theory DSO should come up a little bit from the March 31st levels. But that is probably not a bad proxy (ph).

Maybe going back to the two numbers that you cited for sequential growth in application development -- 14 percent and 9 percent in application maintenance, that's what I wrote down -- can you maybe strip that out for organic growth in each one of those businesses?

I don't have that handy, but the --

I guess where would the majority --

(multiple speakers) sequentially. Sequentially the impact of acquisitions is tiny. It is 200,000 Ygyan and we had Infopulse for half of last quarter, so --

And you had ASIS starting in June.

Yes, so the numbers you are referring to are sequential. The impact of acquisitions is negligible.

Finally, can you just talk a little bit about new client additions? I believe 21 clients came from Ygyan and 3 strategic accounts. Could you talk a little bit about just the pace of new client additions and your outlook on your pipeline?

There are 21 acquisitions from Ygyan and then 23 from the core business, and that included 3 of which were strategic so 20 of that were not classified as strategic.

I am sorry -- 23 from the core and 21?

Twenty-one from Ygyan, right.

So it wasn't 21 of the 23 were not from Ygyan?

No. There were a total of 44 -- 21 from Ygyan, 23 from the core business.

Got it. Thank you.

The number from the core business, as you know, that balances bounces around from quarter to quarter because that 23 includes some very small customers as well. What we focus on is we continue to win strategic accounts at sort of the same level as we have historically, and that's an important statistic to us. So we're certainly very pleased with Q1 results and I think customer wins reflects the interest level of offshore service and offshore services.

Great. Thank you.

Brian Kinstlinger, Sidoti.

A couple of quick questions. First of all, I wanted to delve into a little bit the 40 strategic clients you have. Just curious if you can break it down. How many do you think are mature? How many do you think right now are hitting in the 5 million to $40 million rage on an annual basis and then how many aren't contributing at all?

I can sort of answer part of that. In terms of mature, it's probably five of them. In terms of ones that are sort of north of the $5 million range, it's a handful. A lot of them are ones that we won in the last year, and obviously they take some time to ramp up. And certainly the growth over the next several years, a lot of that growth will come from the 35 of the 44 who are not yet mature. So yes, we have a lot of room left to penetrate these accounts.

And I take it just a few that aren't contributing at all, which was probably from the last quarter or so?

The ones we won in Q1 obviously, yes, not made any meaningful contribution yet.

And the average -- the bill rates, were they the same as last quarter?

Yes, essentially flat.

And this is the final question. What about top 10 and top 5 for revenue?

Sure. Top 5 are 39 percent; top 10 is 55 percent.

Okay, thanks.

Jonathan Debroth (ph), SG Cowen.

Just one question. Does J.P. Morgan still account for greater than 10 percent of the revenues? And are you expecting to see the ongoing relationship to expand following their pending merger with Bank One?

As you probably know, it is not appropriate for us to comment on specific clients and what they're doing. But we do have one client that's about 10 percent.

Okay.

Ashwin Shirvaikar, Citigroup.

Congratulations on your results. I wanted to delve a little bit more into the competitive environment and the Europe versus US situation. Could you comment on how Europe differs from the US in terms of sales cycle, staffing and pricing and who you see there as competition?

Europe it is fair to look at it in two kind of different markets, the UK and continental Europe. If you look at continental Europe, the type of work that you bid there is the development area, the application development, not so much the maintenance or the management, whereas in UK it is a mixture of both.

The increasing set of opportunities is actually from continental Europe at this stage because they are later investors offshore outsourcing, but that are a significantly higher order of interest from that area and they tend to be in the new projects with the development area.

In terms of competition, it's about the local vendors. There are local medium to large organizations that are very aggressive in the European context and offshore players. In the offshore players it tends to be particularly the Tier 1 players from India.

On a separate question, in the US as you higher more local employees perhaps can you comment on what the impact on the cost structure might be in terms of -- right now it is between, what, 15 and 18 percent of cost structures in (indiscernible) in India?

As we start to hire more US employees, it really does not have an impact on the cost structure because remember roughly 30 percent of our people are based in the US and on an apples-to-apples basis in terms of skill set what we pay local hire and what we pay an Indian national when they come over are essentially the same. So as we hire more in the US we don't expect that in isolation to have an impact on the cost structure.

Final question is on your expectation for where in your financial model where currency is going to end up and what your hedging policy is.

Let me start with hedging. We do not hedge. For balance sheet exposure we can create natural hedges, depending on how much cash we keep in dollars versus rupees in India. And that's why you actually saw the FX gain in Q1. But we do not hedge operating income.

As I mentioned, compared to the rate that we experienced in Q1 compared to the current rate the rupee has appreciated about 2.5 percent. We certainly understand how we handle that appreciation and how we can handle some additional appreciation above and beyond that. There's people a lot smarter than us predicting what exchange rates will do. One thing that we did see as positive is the RBI in India earlier this week started to take some action to mitigate the further appreciation of the rupee by reducing the interest rates that non-Indians can earn on deposits to eliminate some of the arbitrage opportunity, and the rupee has actually depreciated a little bit from its peak a little while ago.

Fortunately, only about 25 percent of our cost base is denominated in rupees. So the rupee issue does not hit us as hard as it hit some of the others. We're certainly keeping an eye on it. In our business model we have certainly built some room for some additional appreciation. And we will keep an eye on it.

But is there a number you can provide? What's your pain point? Is 42 rupees to the dollar, is the 41.50?

I'm not sure I have an exact number, but we can certainly handle more appreciation than has happened at this point. And remember we have a lot of leverage down in SG&A that we can get at if we want to. So we're keeping an eye on it, but at this point we don't see it changing the business model.

Thank you. Congratulations again.

Andrew Steinerman, Bear Stearns.

Could you just quantify how much wage inflation we have sort of baked in? You said it's already in place as of January. Do we think January the increases should be the strategy for the year?

In India in January the wage increases were low double digits and that we expect as sort of the major impact. We do give raises related to promotions and a few other things here and there in April. But the big part of the hit already happened in January. The rest is relative noise in the system.

Thank you very much.

Ed Caso, Wachovia Securities.

Can you just clarify -- I think earlier you said you had about 2.5 percent move in the rupee and that's about 50 basis points. So can we say a 1 percent move in the rupee is 20 basis points? Is that a good rule of thumb?

Absolutely. That is the rule of thumb. Maybe 1 percent of appreciation cost me in isolation 20 bps. Obviously I have leverage I can pull to recover some of that as it happens.

Can you talk a little bit about -- Lakshmi, talk a little bit about the verticals, what you're seeing in the various verticals? There's a lot of talk about sort of finance and insurance. What are you seeing elsewhere?

Among the verticals, the finance and insurance verticals continue to be strong. There's a fair amount of discretionary spending that has come back into these verticals. We also see good traction in the retail and the manufacturing sector. The retail and the manufacturing verticals have been a little slower compared to the financial services and insurance in adopting this outsourcing. That's gaining ground. That tends to be more in the maintenance category of trying to reduce the cost through outsourcing the existing systems. We also see a good traction in the pharmaceutical industry. There are a number of pharma companies that are interested in going forward looking at offshore outsourcing. This is both for some complex data management type of applications, as well as for the regular applications maintenance type of work.

Maybe you could talked a little bit about packages. I know you have made an effort here in SAP. What percent of revenue at this point relates to package related work as opposed to custom work, and then sort of split it development and maintenance?

At this point ERP and CRM together are about 11 percent of our revenue, and that's a combination of implementation and maintenance.

And in terms of a trend, I would say that the package implementation maintenance (indiscernible) will probably grow a little bit compared to the legacy systems maintenance as more and more of these products are implemented and are put to use to the client situations. As far as the newer opportunities are concerned, it's unlikely the customers will invest large dollars in building new applications in non-core areas like in the HR or the finance areas. It will be predominantly package implementation.

Thank you.

Pat Burton, Smith Barney.

Congratulations on the quarter. A two-part question. One would be if the expensing of stock options comes about would you change your stock option plan or just give us an update on your thinking there? And the second question is just an acquisition pipeline update. It seems like you've been more active of late, albeit with smaller acquisitions. Thanks.

In terms of expensing of options, clearly we're very conscious of it and we're very conscious of investor sensitivity and to the cost of it. We have substantially reduced our burn rate of options, the percentage of options that we issue each year. This year we're targeting three to four percent, even with the obviously very healthy growth in the business where historically we've done almost twice that. So we're bringing the number of percentage of options down. Is it a significant number for us in terms of the cost once it start having be expensed? Certainly it is because of the high beta (ph) in our stock.

We will be looking over time as things settle down and as it becomes clear how investors are going to think about this, looking at our traditional stock options, the right form of equity going forward. But I think it's still a little too early for us to figure that out until we sort of see how both the shareholder community and the corporate communities starts to deal with expensing. But certainly it's an issue we're watching. We're very sensitive to shareholder concerns on it.

In terms of acquisitions?

Acquisitions, the strategy we will continue to look at smaller tuck-in type of acquisitions. There is a (ph) pipeline of opportunities that we are working on -- wouldn't be able to comment beyond that.

Thank you.

Cynthia Houlton, RBC Capital Markets.

You commented a little bit on competition in Europe. Could you comment a little bit more in detail on what's happening in the US, and specifically some of the US multinationals and how often are you seeing them relative to your traditional competitors?

In some of the larger opportunities I think we do come across the larger US players like Accenture, Keen (ph) and those type of organizations who do talk about the global delivery model and compete with that. So compared to a year back there are more of these organizations who can talk credibly about a global delivery model because many of them have established something in the last one year.

But from a customer's perspective, they look at the maturity of this model and that compares -- compared to some of the newer players who are establishing the facility now, the maturity of the India-centric players appears to be still high. And in an overall context the proportion of wins appears to be higher among these players in the mid-segment. Of course the larger players like the Accentures and the IBMs play in the total outsourcing where they have a higher build rate.

Are you seeing in terms of some of the opportunities a requirements of doing more traditional outsourcing IT services or are you still seeing opportunities that are --? I guess my question is focused on partnering. At some point would you think of partnering with some of the global providers as customers may look for a company that can do more of the traditional IT and outsourcing services?

One is yes. There is a requirement -- or it is considered as a positive -- we are able to do a traditional type of outsourcing where a few that we -- a couple that we have done where we have rebatched (ph) the (indiscernible) and taken them over. I wouldn't say there are indications that it is a trend, but clearly that is seen as a favorable or a positive indicator if some of the offshore vendors are able to offer that kind of outsourcing.

Partnering, unlikely to be significant because it's (indiscernible) to work in different business models, mesh them in a client engagement is going to be a little difficult. Although we have done this type of partnering in some cases, we see that decreasing going forward rather then increasing.

Thank you.

I know it's a busy earnings day for everyone, so I promised that we would end the call in time and it's now 10 o'clock. We like to thank everyone for joining us on our first quarter earnings call and we look forward to giving you another update on our success in July. Thank you very much.