高知特 (CTSH) 2004 Q3 法說會逐字稿

Welcome everyone to the Cognizant Technology Solutions Third Quarter Earnings Conference Call. (OPERATOR INSTRUCTIONS). I would now like to introduce to you, Mr. Kirin Smit9 from Financial Dynamics. Please go ahead sir.

Thank you and good morning everyone. By now, you should have received a copy of the Company's third 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; 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 the 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. Please go ahead.

Thank you Kirin and good morning everyone and thank you for joining us today for Cognizant's third quarter earnings call. On today's call I plan to provide some color on the key drivers behind our continuing success this quarter, broadly 3 areas. In summary, we see 3 key themes emerging. Firstly, that Cognizant's differentiated offering is proving to be an enduring and significant competitive advantage, one that is confirmed by our clients and observers of the state alike. Secondly, we are seeing an increased interest in and appetite for broadening the range of services provided to our clients, utilizing the on-site/offshore model. A good example of this is our recently launched infrastructure services practice. This is where we effectively do not literally own our customers' IT infrastructure but manage them -- manage the IT infrastructure remotely for our customers. This trend towards providing a broader range of services using our model is one that we are seeing across the industry and we are convinced that it is positioning us, and almost as importantly the overall market, for significant further growth. And thirdly, we are seeing increasing signs of traction and general levels of interest in offshore outsourcing in the UK and across continental Europe. I will provide further detail on these 3 areas shortly.

First, turning to our overall performance, I am pleased to report that we had another exceptional quarter with strong growth across our key verticals. We ended the third quarter with revenue of $155.4 million, up 12 percent sequentially, compared with the $138.7 million in the second quarter of 2004, and up 58 percent from the second quarter of 2003. Earnings per diluted share were 18 cents compared to 17 cents for the second quarter of 2004 and 12 cents in the third quarter of last year. Strong demand across our key verticals and a widening scope of relationship with a number of our existing clients allowed us to deliver substantially better than expected financial and operating performance. Cognizant continues to grow faster than any of our key peers in the industry and we believe this is for 2 key reasons; our strong track record in developing strategic services that delivers strong cost and performance benefits to our clients and more importantly our ability to hire and retain talented employees, who deliver and sustain high levels of customer satisfaction.

Our operating margins were stable and our plans assume that they will remain within our historical target range of 19 to 20 percent. Our strategic investment in sales and marketing at much higher rates than our competitors allows for differentiated offerings and higher customer satisfaction levels and growing the business faster than the industry. Additionally, I am pleased to report that the average pricing during the quarter was up slightly due to the solid demand environment from new and existing long-term clients. During the quarter, we added 24 new customers. As I indicated earlier, we have experienced steady growth across sectors and this is reflected in our strategic client wins during the quarter. As you know, we define a strategic client as one offering the potential to generate 5 million to 40 million or more in annual revenues for Cognizant over the long-term. We secured 3 such clients in the manufacturing, retail, and financial services industries.

Turning to our mix of services for the quarter, growth in our application development and integration services has continued to outpace maintenance work for the sixth quarter in a row at the sequential rate of 17 percent. This compares with overall sequential revenue growth of 12 percent. Development and integration now accounts for 47 percent of the total revenues. Although still a small percentage of our overall revenue, we are particularly pleased with the traction we are gaining in our infrastructure service practice. This practice complements our software maintenance business and monitors, manages, and enhances the performance of every element of our clients' IT infrastructure backbone. Our comprehensive service offering is designed to optimize and continuously monitor and enhance the performance of IT infrastructure, including servers, databases, the network, and email systems. The new service line is growing rapidly and we expect this to continue. We already have 22 clients and over 300 staff in this practice. This also speaks toward the expanding market that we can serve and clearly displays our ability to meet customers' requests in new services. It's this responsiveness to our clients and the markets' evolving needs that allow us to continue to deepen our relationships with existing clients, while maintaining a very strong win rate against competitors, confirming our position as a highly differentiated provider.

Turning to our competitive advantages, I'm also pleased to report that Cognizant was ranked in the top category in META Group's METAspectrum report for offshore outsourcers. This report was developed to enable IT professionals to quickly evaluate services firms based on their ability to deliver on the presence and performance criteria that matter most in a given market. Cognizant was featured in the leader segment of the analysis and recognized for the strength and breadth of our service offerings.

Cognizant remains an employer of choice, which can be seen by the consistently higher caliber of candidates we're attracting. We're well positioned to recruit and retain the best people with the technology skills and business-domain knowledge, who allow us to separate ourselves from the competition. It's our expertise and extensive project management skills as well as our reputation for high quality work, solid execution, and follow-through that provides such a strong foundation for winning large and more complex projects. Additionally, our ability to cross sell new services and strong customer relationships continue to drive performance as evidenced by the fact that 92 percent of the revenue in the quarter was from retained clients who have worked with Cognizant for at least 1 year.

To meet continued expectations of demand, we added more than 2000 associates during the quarter, closing the quarter with almost 14,000 employees, which is well above our forecast at the beginning of 2004. We now expect to finish the year with approximately 15,000 employees, up from the ending balance of 14,000 that we projected last quarter. About 60 percent of the net additions are new recruits of recent college graduates. Bringing recent college graduates into Cognizant allows us to maintain the highest levels of quality through our training programs and also to maintain and reinforce our corporate culture, which is a key differentiator. It's also worth noting that this junior staff category is not a key driver of wage inflation. During the quarter, employee turnover was down 1 percentage point sequentially to 16 percent and down 2 percentage points from the year-ago period and was heavily weighted toward the most junior staff in India. As we have said in the past, we expect this number to track in the low teens and year-to-date, we're tracking at approximately 14 percent. Our highly skilled workforce is a key differentiator for us and our ability to attract and retain local talent in this strategic market is one of the principal reasons for our ongoing success and strong momentum. As such, we remain confident in our ability to retain the most qualified employees as we build on our strong competitive position.

Today, we also announced that we're expanding our current techno-complex construction program in India to 930,000 square feet. These new facilities will include 830,000 square feet of space to house 9000 developers in Chennai, Pune, Calcutta, and Bangalore. In addition, the expanded program includes construction of 100,000 square feet of educational space for use by Cognizant Academy for training purposes in Chennai. Cognizant expects to spend approximately $76 million on the expanded construction program, an increase of approximately $34 million compared to the program that we announced in December of 2003. This new program supersedes the construction program we announced last December to build 600,000 sq. ft. of capacity. Work on these expanded facilities is already underway with the first of these facilities expected to come on line in Q2 of 2005.

As the new facilities reach capacity, they are expected to generate significant annual operating savings, compared to the use of leased facilities. Our continued investment in our strategic vertical approach to the market differentiates Cognizant from our competition. During the quarter, we saw strong, balanced growth in our key vertical markets, and we continue to gain traction in the UK and in Continental Europe. Additionally, we continue to see an increase in general interest in offshore outsourcing in this region, and we are receiving a number of enquiries and visits from potential clients. In particular, we have seen increasing demand from the financial services sector, where clients are looking to leverage the offshore benefits for application development projects.

I'm also pleased to report that for the second year running, Cognizant was named the best small company in America by Forbes magazine. This is the fifth time that Cognizant has been named to the list and third time we were ranked number one overall. The Forbes ranking speaks to our strong focus and managing the business for the long term and sharp focus on technology service solutions that deliver measurable business benefits to our customers, which in turn translates into strong financial performance across the criteria on which Forbes bases the rankings.

In closing, I'm pleased to report that the third quarter clearly shows the second half is playing out better than we expected and we are very optimistic about the remainder of the year. Our pipeline of new business remains very strong as potential customer interest levels continue to increase and we continue to broaden and deepen the nature and scope of our client relationship. Based on these trends, we anticipate continued strong performance for the remainder of the year and into 2005. And now I would like to turn the call over to Gordon for a more detailed look into the financial performance and guidance going forward.

Thank you Lakshmi and good morning to everyone. I would like to provide some additional information on the third quarter and then discuss our financial expectations for Q4 and full year 2004. Revenue for the third quarter once again exceeded our prior guidance and internal expectations due to continued application management ramp up, of clients won over the few years, and continued greater than anticipated strength and discretionary development spending, a trend that started of course in second quarter of last year. Our core businesses remain solid and performed 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 53 percent of revenue and application development and integration, the remaining 47 percent. Both services grew in Q3. On a year-over-year basis, application management grew 46 percent and application development and reengineering grew 76 percent during the quarter. On a sequential basis, development grew faster than maintenance for the sixth quarter in a row. Application management grew 8 percent sequentially; application development and reengineering grew 17 percent driven by the trends mentioned earlier as well as 1 percent more billing days in Q3, compared to Q2.

The largest growth driver in the third quarter in terms of gross dollars was financial services, which includes our practices in insurance, banking and transaction processing. It grew $7 million sequentially and represented 48 percent of revenue in the quarter. Healthcare was our sequentially fastest growing segment in percentage terms, growing by approximately $5 million or 17 percent sequentially and representing 21 percent of revenues. Retail and manufacturing grew about $3.4 million and represented 17 percent of revenue, and information services grew $1.3 million and was 8 percent of total revenue. The reminder of our revenues came primarily from other service-oriented industries as well as our alliances.

During the quarter, 86 percent of revenue came from clients in North America. We continue to see an increasing interest level in Europe for offshore services, both from the European divisions of our global clients as well as from an increasing number of local clients. European revenue was 13 percent of total in the third quarter, up from 12 percent in the second quarter of 2004. We added 24 new customers during the third quarter. Our active customer base increased to 219. During the quarter, we were selected as the offshore partner in 3 accounts, which we consider to be strategic; it has the potential to become significant revenue sources for us in the future. We ended work for 18 clients during the quarter, almost all of which were very small clients which, when combined, generated only about a million dollars of revenue for all of 2004. Cost of revenues increased 60 percent for the quarter as compared to the third quarter of last year. The increase is almost entirely due to additional technical staff both on-sided offshore required to support our revenue growth. We increased our technical staff by processing 1950 during the quarter and ended the quarter with approximately 13,000 technical staff. This is a net increase of over 5900 staff compared to Q3 of last year. Gross margin was 45.6 percent for the quarter, an increase of 5 basis points compared to the second quarter of this year and a decrease of 40 basis points compared with the third quarter of last year.

During the quarter, we further increased our bonus accrual to a level well above a 100 percent and above the payout levels accrued in Q2 of this year as well as the third 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 are pleased to have the opportunity to share a portion of this success with our employees. The increase in bonus payout expectations more than accounted for the entire decline in gross margins.

SG&A expenses including depreciation were $40 million, up from $25.9 million in the third quarter of 2003. As a percentage of revenue SG&A was 25.7 percent for the third quarter, down 65 basis points from the third quarter of last year and up 20 basis points from the second quarter of 2004. During the quarter, we continued to strengthen our vertical expertise and we aggressively hired client partners to manage our customer base, a key differentiator for Cognizant.

In addition, we further extended operations in Europe to position ourselves for the emerging opportunities in that region, and we continued to invest in building out our infrastructure of services capabilities. Due to our higher revenue expectations for the year, we are currently aggressively accelerating once again our SG&A expense to further differentiate Cognizant from the marketplace.

Operating income for the quarter increased 60 percent, to $30.9 million, from $19.3 million in the third quarter of last year, and our operating margin was 19.9 percent, down approximately 10 basis points sequentially, and up approximately 30 basis points compared to the third quarter of last year.

During the third quarter, we continued to a long-stated strategy of reinvesting a margin above our targeted 19 to 20 percent range back into the business. As mentioned earlier, we have further accelerated our reinvestment strategy to reflect the higher than anticipated revenue outlook for 2004.

Interest income for the third quarter increased to $1.3 million, compared to 600,000 in the third quarter of last year. Interest income increased due to a higher global cash balance and an increased portion of that balance held in foreign currencies, which have a slightly higher interest rates, and we had a $260,000 towards foreign exchange loss for the quarter. Our tax rate for Q3 was 18.3 percent, in addition our forecasted rate for the full year 2004 remains at 18.3 percent. Turning to the balance sheet, our balance sheet remained healthy, we had finished the third quarter at $70 million of cash and short-term bank deposits, an increase of over 37 million compared to June 30.

Q3 cash flow was positively impacted by the increased level of accrued bonus liability, partially offset by a small uptick in DSO compared to Q2. During the third quarter, operating activities generated $42 million of cash, financing activities primarily the stock options generated just over $10.8 million of cash. These amounts were partially offset by 15.5 million of capital expenditures including expenditures on our India construction program. In addition, we used $500,000 of cash due to currency translation adjustments. Our collection of trade receivables during the quarter remained strong based on our $104 million balance in September 30. We finished the quarter with a DSO including unbilled receivables of 61 days.

Excluding unbilled receivables, our DSO was approximately 51 days for the third quarter. The quality of our receivables portfolio remains very strong. Our unbilled balance was $17 million at the end of the third quarter, up $3.3 million from June 2004. The increase in unbilled receivables resulted primarily from the volume associated with our strong sequential revenue growth, as well as the timing of several growing milestones. Approximately, 70 percent of the September 30 unbilled balance will be billed in the month of October. During the third quarter overall 23 percent of our revenue came from fixed contracts unchanged from the second quarter of this year and down from 26 percent in the third quarter of 2003. When we look at the mix by solution type during the quarter, 28 percent of development revenue and 18 percent of our application management revenue came from fixed contracts.

Turning to headcount, at the end of the third quarter our worldwide headcount including both technical professionals and support staff totaled 13,970. This represents a net increase of approximately 2050 people during the quarter and 4725 people year-to-date. Approximately, 60 percent of these net additions were recent college graduates who will enter our trainee program as a reminder with matter of hiring of experienced IT professionals. Based on our increased portfolio revenue expectations and our year-to-date success in training, we now expect to finish 2004 with approximately 15,000 employees globally up from our most recent guidance of 14,000. It is important to note that due to the focus on college recruiting and associated Q3 seasonal spike, Q3 hiring was well above expected Q4 hiring levels.

Turnover both voluntary and involuntary was 16 percent annualized during the third quarter. Year-to-date our annualized attrition is 14 percent, in line with our previously stated longer-term expectations. The vast majority of Cognizant's turnover occurs in India resulting in on-site annualized attrition rates in the single digits. In addition to the attrition's heavily weighted towards the most senior members of our staff. Going forward we continue to target an attrition rates in low teens in line with our historic levels. On-site utilization once again was just below 90 percent for the quarter. Offshore utilization excluding recent college graduates tour and our trainee program during the quarter was just above 70 percent, including trainees offshore utilization was approximately 60 percent for the quarter. We had approximately 18,000 unbuilt people in our trainee programs at the end of the quarter up from 13,000 at the end of June.

I would now like to comment on our growth expectations for the fourth quarter of 2004 and for the full year. We are comfortable with our abilities to deliver revenue in the fourth quarter of at least $167 million. We continue to have significant revenue feasibility due to our long-term nature of our customer relationship. In fact, today we have customer commitments well over 90 percent of our fourth quarter revenue guidance. As a reminder, Q4 has 4 percent fewer days for us than Q3. For the full year 2004, based on the strong demand by services of a favorable experience with ramp up price, we now expect revenue of at least 581 million, up from our prior guidance of 565 million. As this has been typical in prior course, we expect majority of growth in the remainder of this year will come and ramp up clients of want over tax years. As previously stated we believe that our maximum capacity to recruit and deliver services in the fourth quarter is capped at a year-over-year revenue growth rate of 60 percent.

During the remainder of 2004, we intend to and continue to foresee monitor our spending and expect our operating margin to remain in the 19 to 20 percent level, inline with our historic margin level and prior guidance. As mentioned earlier, we are accelerating investment initiatives due to our stronger than expected revenue performance and outlook. With this expected level of revenue growth and our expected operating margins, we are currently comfortable with our abilities to deliver EPS of 19 cents in Q4. This guidance includes the anticipation of the Q4 share count of between 144 and 145 million shares and tax rate of 18.3 percent operating margins slightly above the mid point of our guidance range and the absence of further non operating foreign exchange gains or losses.

Based on current business trends, we currently expect EPS for the full year of approximately 68 cents up from our prior guidance of 66 cents. This guidance includes anticipation of a full year share count of approximately 143 million in addition to the guidance for tax rate 18.3 percent and our operating margins slightly above the mid point of our guidance range as well as the absence of further non operating foreign exchange gains and loss. We expect the vast majority of our Q4 growth to come from existing clients, particularly the numerous strategic deals we 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 are well positioned for 2005. We are currently beginning the 2005 planning process with our clients. During this process, we work closely with our clients to identify and plan project and resource ramp up's for the coming quarters. Once this project is complete, we will update on our outlook for 2005. However, as I mentioned earlier, we believe we are very well positioned going into next year. Now, Lakshmi, and I would like to open the call for questions. Operator?

(Operator instructions.) Andrew Steinerman, Bear, Stearns.

Could you just go through our trends in pricing for in particular? I know we really haven't varied that much over the sort of course of time, and I heard your general comments about slightly up, but if you could just be a little more specific offshore, on-site, bill rate and what the negotiations are like?

There are a couple of pieces that offset each other. Clearly our new deals, new customers, pricing is up over what it was last year. That gets partially offset by the business as a whole, its moving more and more towards large clients and obviously large clients have lower rates than small clients and the business is off to ship, and we look more towards development and development trends up higher rate, so there is some pluses and minuses going on. When you net all that out, our average rate was up just under 1 percent, so very slight up tick but firmly moving in the right direction, sequentially in Q3 versus Q2. That increase was worked out to be roughly 25 cents offshore and 50 cents plus on-site. So, due to combination of those accounts we've been winning, ramping up lower to higher rates, partially offset our shift towards larger customers and what we are very pleased about, even with that shift going on, the average rate is slowly moving up. I would not set the expectations that's moving up dramatically, but it is clearly headed in the right direction.

And you mentioned if was because of strong demand you've been able to get these price increases. Have customers also been reactive or sensitive to the argument that there is wage inflation out there and if they want the best people, this is sort of the mode that they have to be in -- sort of offering an allowance, some bill rate increases or is that, that are arguments that works well with clients?

I think that's a difficult argument, when we are looking at offshore wage inflation. If on-site wage inflation were to kick in, so far we certainly have not experienced that, but if it were to kick in, that would translate into our client having to give their own staff, wage increases, and then I think there would be a more of a understanding, the need for more material rate increases. But I -- right now it is -- the discussions are primarily driven based on the supply and demand environment and clearly the market is saying that it is going to pay a premium to companies like and some are Tier-1 competitors with vast majority of the deals going to the Tier-1including Cognizant, which means customers are not making decisions based on price, they are making decisions based on quality.

Right and this last, as you tie out there at point. Wage inflations, could you just give us a benchmark for that?

Our wage inflation went into effect early this year, it was low double-digit offshore, very low-single digits on-site. We are just in the middle of the budget process right now for next year, clearly it will be a meaningful wage inflation offshore again, but I remind you offshore wages are only 17 percent of our cost base, so, wage inflation offshore is quite manageable. On-site wage inflation is still going through the planning process, not seeing any red flags at this point but on somewhere not I indiscernible) across this year.

Superb. Thanks for your comments.

Ashwin Shirvaikar, Smith Barney.

My question is actually on, as you move up the value chain, are you seeing a different set of competitors in the market?

Yes, that's a good question. In the most recent competitive situations that we've had, we clearly find that there are about 5 or 6 other companies that we usually see in the mix, that includes some of the large system integrators like IBM, Accenture, here with the domestic players. Plus, the top three India-based companies. So, the mix is heavily tilted towards these limited number of people, particularly when it comes to some of these high value solutions that we offer.

On a separate question, you know, over the past several quarters, you have signed lots of strategic clients and Gordon you talked a little bit about this but are there any metrics you can offer us that tell us how exactly during -- you know, signing up these strategic clients for more business, is there any way you can quantify that?

Ashwin, at a macro level, we're making up very well, obviously as you can see from our revenue growth rate. Once you go down to the detailed level, there are some that are far exceeding our expectations and some of that are nowhere near our expectations. So, there's obviously a wide range in there. But on an average, the wrap up rates continue to be extraordinary.

So, does that mean your average size of client is moving up?

Actually, I would say that because we continue to win new clients, but what happens once we win the clients, the rate at which they grow is very healthy on an average. The average size of the relationship because we continue to win some big clients. I'm not sure you've seen a big change in that, and I'm not sure you will, but we will continue to grow at this pace.

And I guess the final question. You haven't talked that much about '05. But the accelerated hiring seems to -- and the comments on pricing seems to indicate that you could have at least a low-to-mid 50's kind of growth rate headed into the early part of the year at least?

Ashwin, way too early to know that, you know, we are just in the discussions with our clients at this point. Our strategy is to make sure we have enough read what demand materializes. We got quite short a year and a half, two years ago, and we want to make sure that doesn't happen again. Obviously the cost of client retention in India is quite small. As we with clients, then we'll be able to update people, but you should read our hiring now as we want t to make sure that no matter for next year, that you would be in position to meet that demand, but it is too early to know what that demand would be.

Adam Frisch, UBS.

Talking about the hiring capabilities of the Company, what constrains your ability? Is it internal capacity or availability of talent, and we haven't heard about visas in a while, if you could just kind of touch on all those things with regard to your hiring capabilities?

Yes, the primary source of our hiring continues to be at the graduate level from the educational institutions. Since we are hiring in such large numbers, the key thing that we focus on is in developing them before we integrate them into the organization. We put them through rigorous training programs. And there, we spend a lot of time in terms of integrating them with the various teams that we have, teaching them the values and the culture, some of the quality process etc. That's where the bulk of the effort of both the Cognizant Academy and some of the senior management team goes in.

So, if training is the potential constraint, what is the number that would -- that you could train, I mean can you hire 10,000 people next year or is that way off the chart?

Adam, it's both training and integration. You can only have so many new people on our project teams without losing the historic knowledge and without losing the client responsiveness and quality. And the number one thing we've decided, we're not going to let the business grow so fast that it affects our quality. And that's why we said, the fastest we would ever let the business grow would be about 60 percent because after that we think that we'd be running the engine too fast. So, we would have the ability to train and integrate people up to about that level. And obviously, as the business grows to a broader number of people, then you can train and integrate and get bigger because the base of the denominator gets larger. In the end, it's not how many class rooms we have because, you know, as you can see from today's announcement, we're adding training capacity, that new building we're building for Cognizant Academy, can hold 1800 people at one time, but it's how many new people can you put in our project team while maintaining the exceptional customer quality that we offer.

Okay, so may be fair to say that if the demand was there for you to grow your topline at 50 percent, you have the capacity to generate that kind of manpower to satisfy.

Yes. That's right.

Okay. Infrastructure services, first time you spoke about this, I guess, in a meaningful way, as opposed to stuff coming out of our traditional vendors. Can you give some color on why your clients are choosing your services and may be give some color on the size of your clients and scope of services provided to them.

These are, Adam, primarily customers that we are providing application development and management services to. That's the -- at least in the cases that we are working on so far that seem to be a prerequisite since we are managing the application artifacts and the application assets. The natural corollary to that is how about taking over the infrastructure and the platforms on which they run so that we can provide a comprehensive support and solution to the customers. So, that's the primary driver and hither to it wasn't possible to do it on a remote basis, on a 24/7 support from a remote location. Now the reliability of the network and some of the products and tools that have become available facilitates such a high level of service because the reliability of the networks clearly have improved a great deal. So, combining these two provides a great opportunity for us to offer comprehensive services, one on the application outsourcing side and two on the infrastructure side. Going forward, I think we do expect these kind of service to increase as a proportion because this service is something that we can take to every one of our clients particularly for those who are doing the application development work so that we can intensively take over the management of these applications.

And you are not writing checks to your customers, correct, for their assets?

Absolutely, these --

Absolutely not perhaps.

The assets are retained, owned by the customers. We only provide service on top that infrastructure.

Okay. Last question, Gordon, on operating margins. You have been very consistent, thankfully for you that your operating margins have been in kind of that 19 to 20 percent range. Do you expect them to kind of settle in the middle and may be even a little bit lower as you go through with this facility build out or we're still kind of -- is that all in the plans and able to be digested without disrupting the margins?

I do not see the facilities build out impacting margins. Long term, it actually is good for us as own facilities are more favorable on the P&L than leased facilities. But I don't see it negatively impacting margins.

Julio Quinteros, Goldman Sachs.

The question that I have is probably little more theoretical in terms of industry growth rates; if in 2005 the industry accelerates to a 40 percent plus industry growth rate, Gordon, are you still comfortable with your comments that you guys should continue to outpace the industry? I know you are not talking specifically about the numbers, but how can we think about that or how can you couch that?

I think my belief is what you'll see is -- what we have seen this year is that the premium players in the market grow faster than the industry average and the 3 players overall will probably struggle a bit. Too early for us to know what the industry is going to grow at next year. We remain very comfortable with our statements that we expect to grow above the current industry averages I wouldn't want to comment on theoretical number of what the industry average might be next year. I'd be surprised if it moves materially. Obviously, this year we grew substantially not only above the industry average but in our minds more importantly we grew faster than all of our key competitors which I think is an important metric because obviously that means we're taking market share and that's something we're very pleased about that -- not only did we grow faster than the average, but we grew faster than the people we see everyday in the marketplace, which is the other Tier 1players.

And one other kind of more of a theoretical question, I mean when you look at the operating margins for the rest of your Tier 1 competitors, you have Infosys at the very high end delivering 27, 28 percent type operating margins. Can you just remind us or may be just go through it, so that it's crystal clear in terms of, why we should not expect to see a 20 percent plus operating margin for your Company in the next couple of years here?

One of the reasons we think we are growing faster than any key player in the market and meaningfully faster is -- and why customers are looking to us to do a broader range of services, why we are having so much success in complex development projects is it that the very heavy investment we're making to differentiate ourselves, in hiring on-site relationship managers, in hiring on-site industry experts, in building out our infrastructure in Europe. We think these are key differentiators and as the market moves away from domestic players versus offshore players and moves to a small handful of companies that all see it as global delivery players, we think these investments are essential plus to make sure that we're in that league and that customers view is in that league. So there is nothing we like better than our competitors having higher margins because what that means is we're able to have a sustainable advantage over them because -- and be able to differentiate against them.

What are the -- just if you can share the numbers in terms of how many relationship managers, industry experts, what are we actually looking at in terms of actual numbers?

In terms of the relationship and accounts managers we have between a hundred and hundred and fifty of them. The industry experts is a smaller number, but those are -- those people are quite senior. Last year, we were the largest recruiter of the MBAs in India in the IT services front, it's one of the ways we differentiate ourselves, then surrounding these industry experts and relationship managers with very strong business analysts, what can do to differentiate ourselves. So these are big numbers for a company of our size.

Okay and then, I would assume that the wages for these folks that we are talking about are going to be commensurate with what we see -- sort of as industry averages, probably approaching a 100,000 or maybe even more in some cases for the rain makers?

Well, I think It'll be well above that.

Okay, and then may be can you just go through the expenses that your talking about, in terms of hiring client partners, European expansion, the push into infrastructure services, and SG&A spend. Can you talk a little bit about kind of what percentages are going into each one of these as you decide to sort of take up the investment levels for these components?

Yes, I don't have the exact list before me, but -- that is also the -- list you have in your office close differences were also expanding in China we're setting up an operation there. We're setting up operations in Japan to service local clients. So we're moving forward on quite a few fronts. The things you listed are some of the biggest investments. And if I sort of ranking them in terms of dollars, clearly the relationship managers would be number 1, number 2 would be the industry experts, closely following that would be the investment we're making in our program management capabilities and our ability to deliver complex development projects, after that it would be our geographic expansion.

George Price, Legg Mason.

Good morning, nice quarter again. Just a couple of followups, Gordon. First of all, I missed the -- did you give the bill rates, the actual bill rates on-site and offshore? If you did, I missed them.

I didn't, but hang on one second. We averaged about between $24 and $25 an hour offshore and just a hair under $70 on-site.

Okay. And you said 17 percent of your cost in offshore labor. What is that percentage for on-site?

It's about 55 percent of our total cost are domestic labor, 17 percent of our total cost are offshore labor and the balance is infrastructure, depreciation, all that kind of stuff.

Okay. And in terms of the, I guess, wage inflation, is that -- you said you saw it earlier and we're hearing I guess some of other Tier 1guys, it seems like it's taken a little bit longer for it to show up more meaningfully for them, but how has that trended through the year? And you did note that wage inflation at the low end was still pretty low, but that most of the turnover is at the low end. Is that turnover going to correlate into wage inflation at some point? Do you think -- what has been your historical perspective on that?

Yes, a couple of things. Where the -- I think the comment on seeing little wage inflation is literally at the college recruiting level and obviously the turn over doesn't happen right there; it happens after people have been in the organization for a little while. I think you are hearing very consistent message from all the Tier 1offshore players that there is wage inflation offshore. Now each of us are in a different cycle during the year for when we give our raises. So, you'll hear -- yes, some people talk about their raises kick in October, others in April, others in January. But, yes, I think people are consistently seeing wage inflation in sort of the low-to-mid double digits offshore and certainly wage inflation will continue offshore next year.

Okay. And I guess in terms of -- the shifting to another topic of remote infrastructure management, -- you gave the number of people and clients, can you give a percentage of revenue may be something that we can kind of track overtime, as this builds up and can you also may be talk a little bit more about the economics of the businesses -- is there in terms of potential leverage in pricing and so forth, how is that very different in any meaningful way from other parts of your business?

I'll answer those specifically. But also remember that infrastructure services is just one example of how we are broadening our product line. So, I don't think any one of these in isolation are going to be the home run. I think it will be a combination of these things that are going to provide a platform for -- further penetrating account, just like complex development, just like business technology consulting, infrastructure service is another example of that. Currently, it's just over 2 percent of revenue. We are obviously going from 0 percent to 2 percent in a year. So it's roughly at a $15 million run rate in Q3 and clearly we would expect it to grow faster than the Company average of going forward. The infrastructure services probably is one of the few product offerings that we have - - that we've actually hit some leverage as you get to critical mass as you set up your network operation center. So in that way it is a little bit of anomaly compared to the rest of our business where it is leverageable.

Okay and I guess last question. Any thoughts on what's coming down the pipe next year in terms of stock options, that might impact compensation plans in terms of recognizing the expense.

At this point, I would say there's lot of debate going on in Washington at the SEC on exactly what's going to be implemented, and more importantly when is going to be implemented. So we continue to watch that and as that settles down -- we will figure out how does it change equity compensation going forward - - in anticipation of having to expense options in some point of time. We have already taken the burn rate way down this year - - from the time we issued the proxy through next year's proxy. We are talking about 2.5 percent burn rate, where it's totally been 6 to 8 percent. So we have already taken real actions and at this point we need to just watch and see how the legislations and rule settle down.

Moshe Katri, SG Cowen.

Good morning. Good quarter. Gordon and Lakshmi I have a couple following questions -- one -- Gordon I think you mentioned the fact that you have had a proposal pipeline as an all-time high. Is there any way to give us a feel on what sort of growth rate it is and if you look at today versus year ago, that's number one. You've mentioned strategic clients. I think it will be helpful if we can talk a bit about, how many today are basically fully ramped, I think in the past that was may be 5, 6 or are with still the same number. If we look at those numbers may be a year forward, do we ramp up the couple more? And then finally looking at your upcoming contract for negotiation may be you can talk about, is there anything specifically large that's coming up in terms of a major contractor negotiation, is it happen this year, is there a specific time framework -- most of your contracts were negotiated and then do you feel that we can actually raise bill rates on those?

Okay. Starting with the pipeline, as you know it is very difficult to quantitatively measure the pipeline because generally the deals are not 5 years $200 million deals but rather they are hunting licenses. What we clearly seeing is both in the number of deals in the pipeline and more importantly the breadth of industries and that -- the allocation of deals across industries and geographies -- and interpret that as the pipeline in Europe is really starting to materialize. The activity level I was seeing is clearly at all-time high though it's difficult to say what percentage higher is that than a year ago. In terms of maturity, we have 5 strategic accounts that are matured today. So obviously we have quite a few pattern in the ramp up phase. As you know Moshe, some ramp up a lot faster than we anticipate, some ramp up slower than we anticipate, probably some will never ramp up. But on average what we have experienced this year is the ramp up rates have been fabulous. And one thing we are excited about the number of strategic deals in the ramp up phase going to 2005 will clearly be a higher number than the number of strategic deals in ramp up phase coming into 2004. So we think we have a nice tail as we come into the year. On contract negotiations, there is no formal old contract yet renegotiated on January 1, or anything like that. It's just a ongoing process, -- we are always talking to clients throughout the year contracts expire and we are renewing them. So there's no magical date for contract renewals.

Is there anything else, but then, if giving or receiving in terms of pricing trends. Do you feel is there any comfort level that you could actually raise your bill rates on those rate, you know, whenever you renegotiate some of these sales?

I think the answers on some others we may try to increase penetration rates. And so on average - - this year we've experienced a small rate increase, we are still lower price cycles, we will give up to the next year. But certainly, that would be our hope and expectation.

Joseph Vafi, Jeffries & Co.

Good morning. Good quarter. I guess just to follow up on that last question. Talking about the size or I guess the breadth and number of deals in a ramp, need a little color on how the customers are viewing the of their ramp up now versus may be a year ago or we actually seeing company's move forward faster than they were a year ago. And then maybe also if there is any kind of metric around. Average deal size that you can kind of qualitatively view these strategic that if you've seen the deal size actually increase.

Yes, I think in terms of the approach, many of the customers are taking the strategic approach which is top through a top down, driven by the Senior Executive in the organization. So once a decision to outsource has been made with a number of divisions within that corporation that expand. So, to that extent the ramp up is definitely a little more rapid compared to two to one of projects that you have to be initiated. The deal sizes are pretty much the same in its - - like Gordon was saying when we win a strategic customer, it's a hunting license the more service is the more capability we take into that organization. A larger is the pie that we can get from that customer. So that's the reason why we are expanding on the additional services that we want to build in. But if we were to look at in relative terms, yes we are seeing on an average, a greater level of interest to work with Cognizant across the range of services than it was a year or year and a half ago.

And then may be an update on your package implementation, I guess, your ERP business, we are hearing ton of buzz and ton of growth out of those other Tier 1 players, maybe an update on your kind of strategic view of that business line and progress there?

Right, the ERP segment, the business is growing for us too - - we are focusing very specifically on certain types of products and certain activities. You can know that CRM products we have a leadership position, we are recognized to have the, probably the best capability as ranked by independent analysts like Gartner in the offshore space, that's the space where we see a significant ramp up in terms of growth, in terms of new projects, in terms of the SAP and the PeopleSoft area, that is also expanding. We've had a significant number of new recruits added into both of these practices, particularly in the post implementation enhancement and integration work. So we believe that there is a great deal of potential for growth in this area.

Okay and then just one final question, if you can look at the absolute dollar increase in aps and management revenue in the quarter versus the quarter previous on a sequential basis, kind of down still growing obviously, but the absolute dollar incremental gain a little bit less. Is there anything read into that just kind of the normal revenue flow or the way that just small at the end of the quarter.

Yes, I would read nothing in to that, sometimes it is low and slower as the trends in continues to be very healthy.

Cynthia Houlton, RBC Capital Market.

Just one question on the vertical factors which you talked a lot about, how you are seeing the strengths kind of across the group in the pipeline, maybe just a little bit more, may be not so much on financial services, but what's been driving health care and retail in terms of, are these customers that are -- it's just taken longer in the pipeline to make decisions, or is it really a segment that's really moving faster now, just maybe some color on what's going on in the verticals?

If you look at the verticals, traditionally, that they set up being the one time base offshore outsourcing in a big way, they continue to grow, but more recently we have seen in the health care, and more importantly the retail sector. The retailers they have significant margin pressures and they have been a little slow to adopt both in terms of new technology as well as new methods of doing it. But in the last couple of quarters, we have seen significant ramp up in the level of interest as well as perhaps win in the retail sector. It's similar trend we see in the manufacturing sector as well, some of the manufacturing companies, as they get familiar with the outsourcing of manufacturing jobs, the service or the IT services jobs outsourcing is also something on the planning for items for many of these companies. As we have been using a lot of in house development, but with a lot of regulation coming into that industry, more recently the HIPA regulation, external contractors or external partners participated. They are familiar with the outsourcing in that area now, and we see an expansion in that area as well.

And then may be just as a follow up, in terms of -- on these vertical are there specific -- is there a kind of some areas where you can say that financial services customers are looking to do ex type of project or health care is doing certain types of back office. Is there any way to it or they all -- do all the sectors looking at the same types of services?

It's different, if you look at the retail sector, the type of solutions that they are looking at are in terms of logistics, in terms of moving goods, in terms of managing the inventories and more importantly increasing the channels, kiosk based selling than own store, so that's -- you can call it a trend, but it is a different type of application, different type of a business scenario for which we need to provide solutions. In the manufacturing area it's about logistics, and as far as the financial services is concerned they are the ones a little more aggressive in terms of development, applying new technology to the solutions. So you see a greater proportion of development to what's happening in the financial service sector.

Operator I think we have time for one more question.

James Freeman, Fulcrum Partners.

Most of my questions have been answered, but just one topical question. There was news crossed in the during your conference call, that the European Union has approved Oracle's overtures, towards, actually is -- to what extent are you PeopleSoft customers at trends in the offshore with the prospect of Oracle de-supporting the PeopleSoft application code?

I mean in the broad sense, most of the customers and what we see in the market is they are looking to take whatever they can offshore, including packages. There is no specific preference towards the other, it's a kind of a generic trend, however what we see in the PeopleSoft area is a fair amount of upgrade work that takes place, people moving from the earlier version and that's been driving some of the projects that we do, and we believe that will continue for some more time as people adopt a new versions of products that have been launched by PeopleSoft in the last 18 months. Thank you everyone for joining us and we look forward to speaking to you again on our fourth quarter earnings call. Have a good day.

This concludes today's Cognizant Technology Third Quarter Earnings Conference Call. You may now disconnect.