高知特 (CTSH) 2004 Q2 法說會逐字稿

At this time I would like to welcome everyone to the Cognizant Technology Solutions' second 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 conference second quarter earnings release. If you have not, please call my office at 212-850-5686. On the call today we have Lakshmi Narayanan, President 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 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 Lakshmi. Lakshmi, please go ahead.

Good morning everyone. And thank you all for joining us today for Cognizant's second quarter earnings call. I'm pleased to report that we have another outstanding quarter, with solid growth across all of our key verticals allowed us to deliver substantially better-than-expected financials and operating performance, enabling Cognizant to grow faster than any of our peers in the industry.

We continue to build on our industry-leading growth (indiscernible) with our strategic solutions, high-quality employees, strong execution and solid customer satisfaction. We have also continue to reinforce our position as a highly differentiated provider of offshore outsourcing services which is clearly being seen in our ongoing ability to broaden and deepen our relationships with existing clients, while maintaining a very strong win rate against our competitors.

We entered the quarter with a revenue of 138.7 million, up 16 percent sequentially when compared with the $119.7 million in the first quarter of 2004, and up 49 (ph) percent from the second quarter of 2003.

Earnings per diluted share were 17 cents compared to 14 cents for the first quarter of 2004. We remain very optimistic about our opportunities for the second half of 2004 and believe that Cognizant is primed for continued, strong growth momentum in the offshore outsourcing market. In addition, (indiscernible) of this model our highly skilled workforce and strong focus and execution allow us to continue to grow faster than the industry.

During the quarter we added a net of 20 customers to our growing list of premier customers. Of those 20, 3 account for what we would consider to be strategic with the potential to generate 5 to $40 million of orders in annual revenues for Cognizant over a period of time. Cognizant now has approximately 43 strategic clients.

Our operating margin remained stable and we are confident that it should remain at the 19 to 24 percent level. Our strategic historic investments at much higher rates than our competitors in sales and marketing allows our current management cost to be lower for new and larger customers than in the past. Additionally, I'm pleased to report that prices remained stable to up slightly due to the solid demand environment from new and existing long-term clients.

Turning to our mix of services for the quarter, growth in our Application Development and Integration has continued to outpace maintenance work for the fourth quarter in a row at the sequential rate of 18 percent compared with overall revenue growth of 16 percent.

This trend has spurred enormous activity in our new Advanced Solutions Group and emphasizes our capability in executing large and complex projects, outside customers moving to newer technologies, particularly those focused on exploiting the full power of the Web.

The nature of this more complex development projects requires a different type of employee (indiscernible) with strong program management, domain and technology capabilities. Our success in making Cognizant an employer of choice, and the consistently high caliber candidates we're talking attracting, we're well placed to recruit and retain the best people with these types of qualities that allow us to maintain our competitive position.

It is our deep expertise and extensive project management skills and a reputation for high-quality work, solid execution, and follow through that provides such a strong foundation for winning these larger and more complex projects. And these types of projects include parts of an enterprise-wide system for engineering program involving a highly complex architecture, complex turnaround times, a large user base and significant balance sheet impact for a very large health-care customer.

This is a multiyear engagement transforming the way the health care industry does business, and requires deep domain knowledge and advanced system architecture skills. Our ability to cross-sell these additional services is also a strong contributor to the fact that 90 percent of the revenue in the quarter was from retained clients who have worked with Cognizant for at least one year.

At the end of the quarter we announced an initiative in our Advanced Solutions Group, a Cognizant joint Microsoft -- Microsoft mainframe migration alliance which help legacy customers seamlessly migrated critical data and systems to Microsoft's .NET-based systems. Microsoft's mainframe migration alliance brings together technology and system integrators to move applications in aging legacy environments to the more modern and flexible Microsoft platforms.

Many of our larger customers are looking to modernize their systems infrastructure by integrating or migrating from the mainframe. Our alliances with Microsoft and others ensure we bring world-class capabilities of both of our companies to our mutual customers.

Turning to staffing. We added more than 1,400 associates during the quarter, closing the quarter with over 11,900 associates. We continue to expand with plan to finish the year 2004 with more than 14,000 employees, up from the 13,000 that we predicted last quarter.

Additionally, annualized employee turnover was 17 percent during the quarter and was heavily weighted towards the most junior staff in India. Also this is a typical seasonal variation at this time of the year. As for 2003, annual bonus payments were made and a number of our junior staff leaves to pursue higher education in the U.S. universities.

As we have said the past, we expect this number to track in the low teens, and year-to-date we're packing at 13 to 14 percent. Our highly spilled workforce is a key differentiator for us and our ability to attract and retain local talent in a strategic market is (indiscernible) reason for our ongoing success and momentum. As such we remain confident in our ability to retain the most qualified employees available and to maintain a strong competitive position.

To satisfy the strong demand that we continue to experience, we have previously announced plans and are on track with the development of three fully-owned techno (ph) complexes, with over 600,000 square feet of office space with room for over 6,500 employees. As the new facilities become fully utilized, these additional facilities are expected to generate substantial annual operating savings compared to the expanded use of facilities that we have (indiscernible).

In late June we announced the closure of our software development facility in Limerick, Ireland due to the increased cost of operation caused by the significant appreciation of the euro. There are no significant restructuring expenses arising from this move. And all our clients' projects are being transitioned from this facility to our operations in North America and India.

Our enlistment in our strategic vertical approach to the market continues to differentiate Cognizant from the industry and our competition. During the quarter we saw strong balanced growth across all of our key vertical markets. In mid-May Cognizant was recognized with a Life Office Management Association "Excellence in Education" Award, a leading insurance industry accolade. I'm pleased to report that this is the second consecutive year that Cognizant has earned this award. Only 63 of the more than 1,250 LOMA member companies have been awarded this prestigious award this year.

We're able to continually improve the value we provide to our customers through globally accepted applications certifications in each of our verticals. Cognizant has the most mature customer relationship skills in the industry, deep knowledge of the industries we serve, a commitment to professional education, and our unique culture are some of the key reasons why we own this leadership position.

In spite of the (indiscernible) trends that we are seeing, we continue to gain momentum in the UK and in Continental Europe, with strong demand from financial services sector where clients are looking to leverage the offshore benefits of Application Development projects. Additionally, we have seen a general increase in offshore outsourcing in this region, and we continue to receive increasing numbers of inquiries and visits from potential clients.

As we have mentioned on previous calls, we have begun working with global clients in Japan and China during 2003, and we are currently establishing an office in Shanghai, and have begun the recruitment process. We have focused and have the ability to work with our global customers, customers who need their growing needs across the globe.

In closing, I'm pleased to report that the second quarter and the first half of 2004 overall were substantially better than we originally anticipated at the start of year. And we're really optimistic about the remainder of the year. Our pipeline of new business remains extremely strong as the interest level from prospective customers continues to increase. And we anticipate the continued strong performance and increasing momentum across our entire business for the remainder of year. Something on which Gordon will elaborate.

We continue to follow our strategy of reinvesting profits back into the business to keep us ahead of the curve. And it is this commitment to investing in our business, both in terms of infrastructure and people, that has allowed us to be so successful and maintain and enhance our competitive edge, and is the foundation for our continuing success in the future.

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 Cognizant. I would now like to turn the call over to Gordon for a more detailed look into the financial performance and guidance going forward.

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 full year 2004.

Revenue for the second quarter significantly exceeded our prior guidance and internal expectations 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 16 percent sequentially and 59 percent year-over-year. Our core businesses remained solid and perform well. Our pipeline is robust. And we are confident in our ability to deliver healthy sequential revenue growth for the remainder of 2004. For the quarter, Application Management represented 55 percent of revenue and Application Development and Integration the remaining 45 percent. Both services grew in the second quarter.

On a year-over-year basis Application Management grew 46 percent and Application Development and Re-engineering grew 77 percent during the quarter. On a sequential basis, development grew faster than maintenance for the fifth quarter in a row. Application Management grew 14 percent sequentially, and Application Development and Re-engineering grew 18 percent driven by the trends mentioned earlier as well as 3 percent more billing days in Q2 compared to Q1.

The largest driver of growth in the second quarter in terms of gross dollars was Financial Services, which includes our practices in insurance, banking and transaction processing. It grew $6 million sequentially and represented 49 percent of revenue in the quarter. Health-care was our sequentially fastest-growing segment in percentage terms, growing by over $5 million sequentially and increasing to 21 percent of revenue from 19 percent in the first order. Retail and manufacturing grew about $4.4 million and represented 17 percent of revenues. And Information Services grew $3 million to 9 percent of total revenue.

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, who continue to see an increasing level of interest in northern Europe for offshore services both in the European divisions of our global clients, as well as from an increasing number of local clients. European revenue is 12 percent of total in the second quarter, up from 10 percent in the second quarter of 2003.

We added 32 new customers during the second quarter in our core business, up from 23 at last quarter, excluding the impact of our Q1 acquisition. Our active customer base increased to 213. During the quarter, as Lakshmi mentioned we selected an offshore partner in three accounts which we consider strategic and have the potential to become significant revenue sources for us in the future. We ended work for 12 clients during the quarter, almost all of which were very small clients which when combined generated only about $1 million in revenue for all of 2003.

Turning to costs. Cost of revenues increased 60 percent 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 approximately 1,350 during the quarter, and ended the quarter was over 11,000 technical staff. This is a net increase of over 5,000 from second quarter of last year.

Gross margin was 45.5 percent for the quarter, a decrease of 20 basis points compared with the first quarter of 2004 and a decrease of 50 basis points compared with the second quarter of last year.

During the second quarter we significantly increased our bonus accrual to a level well above 100 and well above the pay out levels accrued in Q1 of this year, as well as during the second quarter of last year. This increase resulted from the significant increase in our expected full year performance compared to our expectations just a few months ago. We're pleased to have the opportunity to share a portion of this success with our employees. The increase in bonus pay out expectations more than accounted for the entire decline in gross margin.

SG&A expenses including depreciation were 35.4 million, up from 23.1 million in the second quarter of last year. As a percentage of revenues, SG&A was 25.5 percent in the second quarter, down 90 basis points from the second quarter of last year, and down 40 basis points from the first quarter of this year. During the quarter we continued to strengthen our vertical expertise, and we aggressively hired prime partners to manage and grow our customer base, a key differentiator for Cognizant.

In addition we further expanded our operations in Europe to position ourselves for the emerging opportunities in that region. And we continue to invest in building out our Managed Services capability. Due to our higher revenue expectations for the year, we are currently aggressively accelerating our SG&A spend to further differentiate Cognizant in the marketplace.

Operating income for the quarter increased 62 percent to 27.8 million. And our operating margins of 20 percent was up approximately 20 basis point sequentially and up approximately 40 basis points compared to the second quarter of last year.

During the quarter we continued our long stated strategy of reinvesting in margin above our targeted 19 to 20 percent range back into the business. As mentioned earlier, we're further accelerating our reinvestment strategy to reflect the higher than anticipated revenue outlook for this year.

Interest income for the second quarter increased to $815,000. Interest income increased due to the higher global cash balances and the increased portion of that balance held foreign currencies which earn slightly higher interest rates. We had an $80,000 foreign exchange loss during the quarter, primarily for the impact of the depreciation of the Indian rupee, our net monetary rupee assets in India.

Our forecasted tax rate for full year 2004 is now 18.3 percent. This is down from our prior expectation of 20.3 percent. During Q2 our tax rate was 16.6 percent, bringing our year-to-date rate to 18.3. As you know, a portion of our tax holiday expired this year related to our earliest development centers.

The decline in the forecasted tax rate for the full year is due in part to the higher forecasted revenue which results in a smaller percentage of our overall revenue and profits being impacted by the expiration of the tax holiday on our early development centers.

Turning to the balance sheet, our balance sheet remains healthy. We finished the quarter was over 233 million of cash and bank deposits, an increase of over 34 million compared to March 31. Q2 cash flow was positively impacted by a decrease in DSO compared to Q1, as well as the increased level of bonus accrual.

During the second quarter operating activities generated 30.8 million of cash. Financing activities, primarily the exercise of stock options, generated an additional 8.4 million. These amounts were partially offset by 3.6 million of capital expenditures including expenditures on our Indian construction program. In addition, we used $500,000 of cash due to currency translation adjustments.

Our collection of trade receivables during the quarter was much stronger than Q1 and in line with our historical trends. Based on our $90 million balance on June 30, we finished the quarter with a DSO, including unbilled receivables, of 59 days. Excluding our billed receivables, our DSO was approximately 50 days for the second quarter. The quality of our receivables portfolio remains very strong.

Our unbilled receivable balance was 13.7 million, up $1 million from March. The increase in unbilled receivables resulted primarily from volume associated with our strong sequential revenue growth. Once again, over 65 percent of our quarter and unbilled root balance will be billed this month.

During the quarter overall 23 percent of our revenue came from fixed bid contracts, unchanged from the first quarter of this year, and down from 26 percent in the second quarter of last year. When we look at the mix of (indiscernible) solution types during the quarter, 29 percent of our development revenue and 19 percent of our maintenance revenue came from fixed bid contracts.

Turning to headcount, at the end of the second quarter our worldwide headcount including both technical, professionals and support staff totaled 11,920. This represents an increase of approximately 1,430 people during the quarter and 2,680 year-to-date. 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.

Based on -- as Lakshmi mentioned -- based on our increase of full year revenue expectations and our year-to-date success in recruiting, we now expect to finish 2004 with more than 14,000 employees globally, up from our original expectation of over 13,000. We continue to expect a majority of the hires to be recent college graduates who will participate in our entry-level training programs.

Turnover, both -- included both voluntary and involuntary, was 17 percent annualized. Year-to-date our annualized attrition is approximately 14 percent, in line with our previously stated longer-term expectations. Approximately 90 percent of our turnover occurs in India, resulting in on-site annualized attrition rates in the single digits. In addition, attrition is heavily weighted towards the most junior members of our staff. Going forward we continue to target attrition rate in the low teens, in line with historical levels.

On-site utilization was once again just below 90 percent for the quarter. Offshore utilization, excluding recent college graduates, who are in our training program during the quarter, was approximately 73 percent. Including the trainees, offshore utilization was slightly over 60 percent for the quarter. We had approximately 1,300 people in non-billable training program at the end the quarter.

I would now like to comment on our growth expectations for the third quarter of 2004 and for the full year. We're comfortable with our ability to deliver revenue in the third quarter of at least $150 million. We continue to have significant revenue visibility due to our high-level of recurring revenue and long-term nature of our customer relationships. In fact, today we have customer commitments who are over 90 percent of our third quarter revenue guidance.

For the full year 2004, based on the strong demand environment for offshore service and our favorable experience on ramp up rates, we now expect revenue of at least 565 million, up from our previous guidance of at least 530 million.

As has been typical in prior years we expect a majority of our growth in 2004 will come from the ramp up of clients won over the past few years. As previously stated, we believe our maximum capacity to recruit and deliver services in both the third quarter and full year is capped at a year-over-year revenue growth rate of 60 percent. During the remainder of 2004 we intend to continue to closely monitor our spending and expect our operating margins to remain in the 19 to 20 percent range, and in line with our historic margin level and prior guidance.

As mentioned earlier, we are accelerating investment initiatives due to the stronger than expected revenue performance and outlook. With this current level of revenue growth and our expected operating margins, we are currently comfortable with our ability to deliver EPS of 17 cents for Q3. This guidance includes the anticipation of a Q3 share count of slightly over 143 million shares, a tax rate of 18.3 percent, and the absence of further nonoperating foreign exchange gains or losses.

Based on current business trends we currently expect EPS for the full year of approximately 66 cents, up from our prior guidance of 59 cents. This guidance includes the anticipation of a full year share count of approximately 143 million shares. In addition the guidance assumes a tax rate of 18.3 percent and the absence of further nonoperating foreign exchange gains or losses.

We expect the vast majority of our Q3 and 2004 growth to come from existing clients, particularly the numerous strategic deals we have won in the past few years. Based on the feedback we have been receiving from these clients about their intentions to leverage the advantages of offshore, combined with the strongest sales 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 both 2004 and 2005.

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

(OPERATOR INSTRUCTIONS). Adam Frisch, UBS.

Way to keep your streak alive here of awesome execution. I wanted to start off by addressing the leverage in the model. You said you over-accrued bonuses, the D&A is going down, your operating margins were at 20 percent. The top line is going to kind of be capped -- I say it with a fair degree of sarcasm -- at only 60 percent.

But does that mean that with way things giving better and more leverage in the model that we might see margins go above that at some point, if you want to keep the wheels on and keep the growth in control?

I would not have any expectations that we would take margins above 20 percent, Adam. In the second quarter way we got a little surprised by how strong revenue growth was. So it wasn't until the latter part of the quarter that we really cranked up the investment spending above even the levels we had already been. So there is just some many good investment opportunities right now, both in terms of expanding our product offering, expanding geographically, building domain knowledge, looking at acquisitions. So we're going to reinvest into the business. We think by doing that we can grow meaningfully faster than the industry average. And that investment has paid off so we're going to continue that strategy.

It is certainly not broke, so don't try to fix it. Drilling down a little bit into the ASP (ph) development results, this has been obviously the key for the upside to revenues and EPS in the past and continues to be. With an angle on sustainability, can you just give us a feel for what you're seeing out there, and what makes you believe that the growth here is sustainable -- not necessarily at the rates you're seeing, 77 percent obviously that's not -- but what makes you feel that trends within the industry will be able to continue the growth within that development?

We see a majority of our customers enlisting in some of the new initiatives. Over a period time they have realized significant benefits and savings by outsourcing some of the maintenance type of work, which makes available significant dollars for them to reinvest in new applications developers, and that is the opportunity. Combined with the savings, there is also a certain amount of increased investment in new initiatives, primarily in investing in new technologies. That is our -- we will continue to see over the next few quarters in terms of additional investment and new initiatives.

And, Adam, also we are benefiting from an underlying trend of clients and how comfortable spend. We have a much broader range of development work offshore. Projects that a few years ago they would not have been comfortable sending offshore, they now are. So we're able to go after much larger pieces of the development pie than we had as Darkly (ph). And I think (multiple speakers).

Picture of what kinds of things?

More (indiscernible) development projects that require not just technology expertise but also deep understanding of the client's industry and business challenges. So as we have more of the business analytics skills, which is a broader range of services.

And then a final question. Obviously, the weakness in software in the last quarter kind of spooked some people on the services side. What are you guys seeing at development obviously being up so much kind of offers a counterpoint from for what we were seeing in software. What are you seeing on the package side?

On the package side the demand continues to be strong. Although as you know, we flail (ph) less than the new implementation of packages, which they lost more into the cost implementation work of the packages (indiscernible). There the demand from our customer base is quite strong, a fair amount of integration activities (indiscernible) part of the application integration services. But the growth there is strong, particularly in some of the well-known products like the Asaysi (ph), PeopleSoft, Oracle and Siebel.

Thanks, guys. And again, congrats on the quarter.

Ed Caso, Wachovia Bank.

Congratulations. Can we drill a little bit more down on the turnover? You mentioned that the 17 percent was both voluntary in total, and also that was a typical seasonal high quarter. Can you tell us what the quarter was a year ago, and what efforts you have in place to bring that number down?

Let me answer on a year ago and then Lakshmi can talk about both the efforts to bring it down and what we think (indiscernible) naturally happened because of seasonality. Second quarter of last year we were at a 14 percent annualized rate. And third quarter of last year we were at a 17 percent annualized rate.

This is typically what happens at the end of year that the first quarter, the bonus disbursements for the people happened -- for most of the people. And that is an activity that happens to be an event that many of the people are waiting for before they take their vacation.

And number two many of the people at the junior level who have spent one or two years in organization, who want to pursue higher studies, education both here and the U.S. and development business quarters in India, the turnover is around this time.

Thirdly, certainly the level of activity in terms of new companies setting shop in India has increased. Compared to last year there are more companies aggressively hiring in India, so that also contributes to the attrition in the organization. What we're trying to do in order to manage that is continue with the performance management that we're known for in terms of trying to retain the top people in the organization, look at multiple disbursement titles (ph). Look at multiple promotion titles in the year during the ongoing quarter as some of the things that we can do in order to increase the level of retention.

Are you losing anybody above the very junior level to these new companies?

Traditionally at the senior -- at the managerial levels our attrition has been in the low single digits. That continues to be the same. At the middle level, again, it is much lower than the 17 (indiscernible) quarter. That is also a traditional strong area for us because people are assigned to challenging assignments, options and so on. The bulk of it is at the lower level. The bulk of it is at the lower level.

The way to look at it is some of the newer companies who do not have the training infrastructure to hire people from engineering campuses like we do tend to pick people who have already been trained by companies like Cognizant to ramp up their pace, and that is what we see happening.

Historically my memory is that part of the reason you have low turnover is your use of stock options. Have other newer, smaller companies embraced the use of stock options or that still not the norm?

That is not so much the norm. However, the stock option continues to be a way for us to retain the people. And our stock options are the middle to the upper management level. And as I said the attrition at these levels are very, very low.

Can you talk a little bit about your efforts in Europe? The closing down of Limerick facility was that just a cleanup of the legacy INS work or is that an indication of demand, or how should we interpret that?

That is more a business (indiscernible) in terms of operating efficiencies. This is a facility that we acquired two or three years back from one of our leading customers. And what we found was that over a period of time, with the strength strengthening of the euro, it became increasingly unviable to continue that operation. And that was the primary reason for scaling back over the next 12 months.

Originally the plan was to use the Limerick facility to track European customers as an entry point to try outsourcing. When we acquired facility the euro it at about 90 cents to the dollar. It is now at about $1.23, and European customers have become more comfortable with growing going directly to India. So when you combine those two things, we found clients won't willing to pay the fairly significant premium we would have to charge to do the work in Limerick instead of offshore.

Last question. On an apples-to-apples basis, what is happening with pricing? And is your pricing flat because of the mix, the larger clients, or can you give us a handle there?

Sure. There are a couple of things going on. Clearly the business continues to shift towards larger clients. Larger clients have lower rates than smaller clients. But that is more than offset, because as Lakshmi said, pricing is flat to up slightly so there is slight increase in average pricing during the quarter. That is more than offset by the fact that we're shifting a little bit more towards development, which you can get a little bit higher price on because it tends to be more specialized skills. And the contracts that we been winning over the last year have been at higher rates than the contracts prior to second quarter of 2003. So we're clearly trending in the right direction on pricing.

Thank you. Congratulations.

Moshe Katri, SG Cowen.

Again congratulations. I wanted to focus on a couple of things. Can we talk about wage insulation? Specifically looking into 2005, maybe looking at your crystal ball? And then maybe you can also talk about the number of these applications that we have in the pipeline now in the U.S.?

As I was just -- talk about the wage inflation, as we indicated earlier the wages remain pretty stable at the entry-level. The bulk of our recruitment is at the entry-level college graduate, where it is pretty flat. At the middle level we say see some escalation as far as wages are concerned. That is something that we're watching. From an overall perspective, not a significant factor.

But our model has been to have a significant variable component which is -- which leverages people's (indiscernible) performance. And so don't see a significant impact for the rest of this year. Going forward it is very difficult to predict where it will go, but it is unlikely to lead to a runaway wage inflation. That is as far as the wages are concerned.

As far as the research is concern, yes, maintaining a fairly healthy pipeline. We're preparing for the next year. Of course we have a planned program of identifying people applying for them in advance. I think that program is well underway. Even that we will continue to maintain the 70, 30 mix, we're planning on that basis.

To we have a specific number for these applications for this -- for for the next year?

We don't -- for competitive reasons we don't disclose the specific number. But it is, clearly as we're planning for next year, we're making sure that we have enough visas in the pipeline to support our growth.

And based on what you have to today in terms of when some of the new client wins that you had in the past two quarter -- and I'm assuming some of it -- most of it will transfer into growth in '05. Do you have anything to say about 2005 as we look -- we're not that far from there?

It was just way too early, Moshe. Clearly the stars are aligned very well for us for '05 in terms that we have a very healthy stable of clients who work in a ramp up phase. Only a handful of our clients or mature at this point in the strategic accounts. So we think that a lot of tail wind from the existing client base and the pipeline is at a record level.

We go through our planning cycle in the fall, but more importantly it is only in the late fall when we sit down with our clients and help them in their budgeting process, and that is when we really get the view into the year. We would certainly expect to grow at a rate faster than the industry overall, but it is too early at this point to know beyond that. But the stars well aligned at this point.

Can you remind us how many of your 43 strategic clients are considered mature today?

I think 4 or 5 are mature, so a very, very small portion of it.

Basically still the same number? It hasn't really changed?

Yes, no further clients have matured during the quarter.

Finally going back to Adam's questioned regarding operating margin, I guess the model will continue to be you are going to cap margins at 20 percent. And then you will redeploy the rest just for growth, just expanding and investing in infrastructure? Am I correct?

Yes, infrastructure is very broadly defined. It is everything from hiring relationship managers to building out our presence in additional countries to expanding our product lines. So a broad range of initiatives. It is still early days on the growth path for this industry, so our view is we want to make sure we win more than just a disproportionate share of the deals. And that we're able to ramp them up effectively. So we do not want to grow above 20 percent. Historically we have grown to the midpoint of our range.

We are very comfortable staying in the 19 to 20 percent range, but we are significantly turning out the investment, the spend right now, which comes back to question about next year. Clearly further benefits us in terms of our position for next year.

Pat Burton with Smith Barney.

This quarter a two-part question. Gordon, what would you anticipate the tax rate and the share count to be in 2005? I don't mean to put you on the spot, but there was some noticeable change there.

And then the follow-up, the second question is on your substantial cash balance. Any update on acquisitions or what the Company plans on doing with your ever building cash balance?

I will start with the tax rate. In my models right now I'm using 18.3 percent for 2005 as well. Obviously if regulations change it could change, but that is as good a guess as any, and similar to what I am using in my models.

Share count is partially dependent on the share price because of the options outstanding. But historically there is about a 5 percent share count through the year. That ballpark.

And then on the cash balance, any (multiple speakers).

Clearly we continue to build our cash balance, which is important in this industry as we're continuing to compete in much larger deals. Clients want to see a healthy balance sheet. Not because we have the to use the cash to actually win the deal, but they're betting their businesses on us. They want to know we are going to be around for the long-term.

Where we used to think $100 million was enough cash on the balance sheet to keep all the customers happy, as the relationships are getting bigger and bigger I think the amount of cash you have on the balance sheet to give the customers that comfort continues to increase.

That being said, we are looking at acquisitions. We will spend some cash on acquisitions there is no question about that. We also generate a lot of cash. So near term it leaves some for construction, some for acquisitions, and the rest will continue to build on the balance sheet, which I think helps us to win deals.

Thank you. Great quarter, guys.

Julio Quinteros, Goldman Sachs.

Can I start off real quick with just a couple of the normal maintenance numbers? Can you just run us through the effort (ph) mix, onsite/offshore, the average rates onsite/offshore? And if you can just repeat the utilization numbers that would be great?

Sure. Let me work backwards there. Utilization on-site just below 90 percent. Offshore, excluding trainees, 73, including trainees, just over 60. Give me one second here. The on-site/ offshore mix was right around 28 or 29 on-site, 71, 72 offshore.

So we shifted slightly offshore during the quarter but a very slight change. Billing rates on-site were up a little bit. We are up about $1, so we were around $69 an hour on-site and 24 and change offshore. And that is driven by as we move a little bit more towards development we can get a little bit higher rates on some of that stuff.

Now on the promise that you made about the reinvestments, is there a sense that you can give us on how many sales and marketing people did you add in the quarter? What were the specific levels on the accruals that you actually put through in your model customers? Maybe to just get a little bit more granularity in terms of how you're actually capping the margin at 20 percent?

Clearly we added some salespeople, but that is not the big dollars. The big dollars are the relationship managers, the client partners, the industry expertise folks. And we continue to add those. I don't have the exact number in front of me, I would get back to you with that. But we add those that are fee and take (ph), and those are fairly high-priced people.

We hired someone to head up -- who was going to run our operation in China. We have strengthened similar capability in Europe. So it is much more than just the actual quota carrying salespeople, though that group we have increased as well. I'm sorry, the second part of your question, Julio?

Just in terms of the accruals, some of the other items or the leverage that you're using to keep the margin capital, I'm just trying to get a better sense on what other --?

In terms of accruals there is no magic there. The main thing is we took an expected bonus pay out that we can pay this year up fairly significantly. Due to -- obviously we take revenue guidance up about $35 million. So that was a reasonably large number, and that exceeded the impact -- that was more than the total impact on gross margin. But that was quite material. But that is really the only thing in accruals is bonus accruals.

And then just finally on the acquisition front, did you talk specifically to acquisitions or what your plans are going forward?

We continue to look fairly aggressively. We're a firm believer niche acquisitions can add real value to your business, whether it be a geographic acquisition to expand our footprint in Continental Europe, or a technology acquisition, for instance, to expand our capability in Managed Services. We continue to look for something in SAP and also in vertical expertise. That is something we continue to look for.

And as offshore -- and particularly Cognizant has been very successful -- smaller companies are quite intrigued about joining up with us because they now really see and understand and believe in the value of the global delivery model that we offer. But the focus is clearly still on relatively small acquisitions.

I'm sorry, one last question on the expenses. I meant to go back to this one. The rupee, how much did the rupee benefit margins in the current quarter?

Compared to Q1 it actually hurt us very slightly. But in Q3, if the rupee stays where it is right now, it will actually help us fairly significantly. The rupee on average in Q1 was a little over 45. In Q2 it was just under 45. And obviously it is up around 46 right now. So that was not a material impact sequentially, but certainly if the rupee stays where it is right now it will be a material benefit sequentially in Q3.

Cynthia Houlton, RBC Capital Markets.

Just wanted to go over just a couple of things on the customer side. Could you just give us the largest customers, top 10, and then top five as part of the total?

Sure. Once again we only had one customer over 10 percent. The top five customers were 38 percent of revenue. Top 10 customers were 53 percent of revenue.

And then in terms of what -- you mentioned UK driving a lot of the growth in Europe. What percent of -- as we look at revenue in Europe overall, I think it is about 12 percent. How do we look at -- how much is Europe of the concentration of that?

The UK is 11 of the 12 points.

And then just a final question. Could you characterize -- you have to provide a robust pipeline. Could you characterize a little bit more in detail what you're seeing in the pipeline? Is there any change, any growth from areas that you haven't seen historically, or just a similar mix to what your revenue concentration is now?

I think it is -- certainly a change from 18 months ago, where the pipeline was very heavily financial services -- very consistent with what we have seen over the last two or three quarters, where it is much more balanced, a lot of activity in health care, increasing activity in telecom, a lot of activity in retail and manufacturing. So a very well-balanced pipeline right now.

Joseph Vafi, Jefferies & Co.

Great quarter. I thought maybe we could drill down a couple more questions on the app development business. Kind of specifically if we rewound clock a couple of years and looked at the mix of resources devoted to it in terms of a mix being an on-site/offshore percentage, it sounds like there is more of the mix going offshore, and that might be part of the reason for the ability to scale at larger -- where do what you see that going over the next couple of years? Is it going to continue to trend moving offshore in terms of the mix of the services being provided there?

In terms of the overall mix, we would see it right around 70 persons to 30 persons. That would be 70 persons offshore and 30 on-site. If you look at the proportion, the Application Management side and the Maintenance side, the offshore component has increased actually compared to a couple of years back. There is a great greater proportion of work that can be done offshore with a lesser proportion of people on-site.

However, as we get into some of the most complex developments in the application development side, particularly during the initial stages, the resources that we have to deploy on-site is higher. It tends to be anywhere from sometimes between 35 to 40 persons or maybe even higher than that. So given that overall we believe that the mix would be 70, 30, and the trend would be Application Management increasingly offshore driven, the application development would be 40 persons on-site, 50 persons offshore.

So we don't really see any big change in that kind of -- in terms of the resource deployment on-site/offshore on the development side?

The most significant change that you would see progressively probably a minor shift towards offshore. But (indiscernible).

Another question on that business, Lakshmi. Kind of from where you sit and what you see, clearly an outperformance on the development side. Could you maybe characterize where that outperformance might be coming versus other companies -- do you see a share shift towards you? Do you see an ability just to maybe capture more business that was being done internally at your customers? Or is it may be something else out there?

I would characterize it by saying it is much more of an internal work that is coming at our way. Two reasons for that. First and foremost is the comfort level on the part of most customers to use offshore partners for some of these large development exercises.

And the second part is, and I did talk about the Advanced Solutions Group, the investment that we made in the last true 3 to 4 quarters in terms of hiring domain experts, technology specialists, high-end program managers, system architects -- you know this team of people will give us the ability to compete for some of the larger projects. These are right now -- some of these -- one of the examples I mentioned was a transformational type of work that the business model is being transformed by one of the customers using technology heavy (ph) -- requires (indiscernible). It is those types of work, because we have the people, because we were able to invest early enough that we are winning more of them as opposed to being done internally by the client.

And then maybe just one more there. If you looked at your development business, especially maybe with your captive or current customer base, how much development business that your winning today or new businesses coming online would be competitively bid versus the sole sourced among your current customer base?

I don't have the exact numbers. But based on what we have seen I would say that there is an equal number of these application development from new customers that we win from outside. If I were to venture a guess it is almost half and half. Half would be from the existing customer base and the remaining half would be new application development work that we win from customers for the first time.

Then then maybe just one final one for Gordon. I know in your comments you talked about maybe some increased visibility in the ramp up rate on new engagements. Can you maybe talk about -- some more color there in terms of are you seeing more business faster from the new wins than you might have previously? And why that might be?

Clearly the big driver continues to be the existing customers ramping, but as we're starring to win some new clients who start with development instead of application maintenance, by nature development projects can ramp up faster. So the new customer wins are kicking in a little bit faster than they have in the past. But that is more driven by the fact that where in the past there had not been a whole a lot of new customer wins that started the development we're having some. The big driver of growth continues to be the driven customer base.

Great quarter. Thanks.

Ashish Thadhani, Brean Murray.

Great quarter. A quick question. If you were not over investing in the business, so to speak, what would the operating margin be?

That is tough to say because it is the way you draw the line in overinvestment. But in my mind is you're clearly a couple hundred bits. Yes, there is probably a couple hundred bits.

Secondly, on the tax rate you mentioned that you expect sort of a flat number going into next year. But with the expiration of the tax holidays over time shouldn't it begin to go up?

The next expiration that we face is in 2007, so there's nothing structurally that have us go up in 2005. Once again obviously regulations can change.

Great. Thank you very much. Terrific quarter.

Sandra Notardonato, Adams, Harkness & Hill.

A couple of questions. Along the lines of application development, you did indicate that there was an increase in rates. Can you be little bit more specific on what you're seeing there?

On development we tried to fix bid some of that. And because of the nature of development work there is more risk involved and we have to use more senior people, so we can charge an underlying higher rate just because it is more complex work and you need more of a diamond than a pyramid. So it is nothing -- it is not that we're going renegotiating rates with clients. That is not happening intra quarter. But it is more -- you know, your fixed business stuff use some highly specialized skills, so on the rate card those highly specialized skills are -- and always have been -- at higher rates than the more generic skills. It is just for the first time clients are actually using those specialized skills.

And to the extent that you do see competition on the application development side, what companies would you cite, both U.S.-based as well as those that are based offshore, that have equal skill sets to you?

In terms of the competition clearly the limited (ph) player is particularly the large ones -- all in the play for some of these large development projects. The likes of Accenture, (indiscernible) companies like Sapient as well and that mix.

And then the top tier players in offshore are the people who compete for this business. And as I said earlier, it is clearly the ability to execute some of these large engagements with a good team that gives the advantage of the competitive edge to us. And that we believe we have better placed than some of our offshore peers.

One of the things we are actually pretty excited about and really attests to the fact that clients are willing to send a broader range of development work offshore, we are running into the Accentures and IBMs a lot more than we used to. And it is because we're now able to go after the type of deals, development deals, that historically were not considered for offshore. So it attests to the fact that are our pie is getting bigger.

When you compete with Accenture, IBM, and you mentioned that once in a while you see Sapient, are you better priced than them or can you at this point in your development as a company say that you deliver as good of skills as they do?

It is more the proven model that helps us win. Because we have been at it for much longer than some of the others. That gives us the ability to execute it well and. Based on the past track record of great delivery, we seem to be winning our share of the business.

And in terms it greatly depends on -- are the competitors bidding it using an offshore model or are they bidding using 100 percent domestic model? Obviously if they are using a domestic model we're going to be dramatically less expensive.

Where they bid using a offshore model, pricing tends to be quite similar.

Where we tend to win is because we're really good at delivering using offshore model.

Is it fair to assume that most of the companies that you cited are now using an offshore model when they do compete?

Yes. That is something that I would say is an increasing number of these proposals are assuming an offshore component.

Just shifting gears here. Along the lines of operating margins, they were 20 percent this quarter. What would they have been had you not reinvested in the business?

It depends on the where you draw the line on what is reinvestment versus what is normal. Certainly, there's a couple hundred bits of -- I will call it overinvestment in the business now.

And you mentioned what you had you spent up. I won't go over that again. If we could just talk about your strategic clients. What is the average revenue that you are currently getting from the 43 strategic clients that you have?

I don't have that handy. But I will get back to you later on today with that one.

Is that trending in an upward direction or is it flat?

I have got to check on that. The issues -- we have continue to win so many, and obviously when they start -- the zero revenue. So I've got to look at that. I be guessing if I answered it.

Just a couple more questions. Lateral hires versus campus hires this year, it was 60/40 this quarter. Is that what we should anticipate for 2004 in terms of the breakout?

No, this is -- we're getting into the campus hiring. The people that we offered last year would be joining in the remaining six months. So overall the proportion that will train a little more to us more like 70, 30,. 70 persons from campus and 30 persons from lateral hires.

The manufacturing and logistics vertical, I know you looked at English retail, but can you give us an update on how that is doing in comparison to what you were projecting for the year? And an update on your build out in Calcutta?

The manufacturing logistics and retail, those are the two segments that are doing well. Traditionally the clients in this space have not been extremely enthusiastic about offshore outsourcing. But that is something that we're seeing a significant change in. More and more of these customers are under cost pressure and they do want to deploy new technologies. So there's an increased level of activity as far as the manufacturing and retail customers are concerned.

As far as Calcutta is concerned, we're in the first phase of (indiscernible). It is operating to full capacity now. We have started leasing space outside, and we will continue to grow that center with both hires.

And we are in the process of starting construction on additional technical complexes in Chennai, Punai and Bangalore, but because of the growth in has been a combination of programmer facilities as well as (indiscernible).

Have you broken out -- forgive me -- I don't know this number off the top of my head -- have you broken out what you're CapEx plans are for this year?

Ballpark around 40 million, and that is fairly heavily back end loaded, because obviously over the year getting more architectural designs. And later in the year we start digging holes in the ground.

Great quarter.

I think we have time for one more question.

Andrew Steinerman, Bear Stearns.

I saw an article last week that Cognizant announced an opening of a China facility, maybe 100 heads or something. Was that accurate, and can you just describe to us how China fits into your overall strategy?

China, as Gordon mentioned, we hired the person who started the factory operations for us in China. There are a couple of small projects that we are executing in China for our existing customers. We're looking to set up a center in Shanghai. The plans are being made as to the -- it is going to be a slow growth in terms of numbers of people and their headcount over the next 6, 12 to 18 months we would see that kind of headcount grow. And n the real growth is going to be in the later years.

But to be clear, Andrew, there is not 100 people. We are currently opening up, and if we're at 50 people at the end of the year we would be very happy.

Thanks so much.

Everyone, thank you very much for joining us this morning, and we look forward to speaking with you again on our next earnings call. Have a good day.

This concludes today's Cognizant Technology Solutions' second quarter earnings conference call. You may now disconnect.