高知特 (CTSH) 2004 Q4 法說會逐字稿

Good morning. My name is Michelle and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Cognizant Technology Solutions fourth quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer period. If you would like to ask a question during this time, please press star and the number 1 on your telephone keypad. If you would like to withdraw your question, press star and the number 2 on your telephone keypad. Thank you. I will now turn the conference over to Mr. Kirin Smith with Financial Dynamics. Mr. Smith, please go ahead, sir.

Thank you and good morning, everyone. By now you should have received a copy of the Company's fourth quarter and year end 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'd like to remind you that some of the comments made on today's call and some of the responses to your questions may contain forward-looking statements. These statements are subject to the risks and uncertainties as described in the Company's earnings release and other filings with the SEC. I would 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 fourth quarter and full year 2004 earnings call. I shall provide an overview of the highlights of the quarter, some detail behind the key drivers to the performance, and our view on emerging trends in the industry, before handing over to Gordon, who will take us through the numbers in a little more detail. I'm happy to report that Cognizant had another record quarter and year celebrating strong performance in our key financial and operating metrics. Outsourcing remains an expanding global trend and Cognizant performance continues to set the pace for the industry. During the fourth quarter, we experienced strong growth across our key verticals, including our newer verticals such as retail and manufacturing. Additionally, we saw increasing overall attraction in Europe where the growing interest in an acceptance of offshore outsourcing is translating into additional customer wins, particularly for our application development services. We have also continued to grow our customer base while our enhanced service offerings have allowed us to expand and strengthen our relationships with existing clients. It's our ability to cross-sell new services and strong customer relationships that continue to drive our performance. A clear reflection of this is that approximately 90 percent of our fourth quarter revenue was from retained clients who is have worked with Cognizant for at least one year.

Now looking at 2004 as a whole, Cognizant's performance stems from sharp focus on our customers' business challenges and [inaudible] measurable business systems. We have an expanding range of new offerings and services. Our reputation for operation excellence, an ability to manage highly complex large- scale projects, coupled with our broad base of strategic clients, many of whom are currently in the ramp-up phase, we believe we have entered 2005 with a strong platform for continued growth. Looking at the overall performance of the quarter and full year, we ended the fourth quarter with revenue of 172.8 million up 11 percent sequentially compared with 155.4 million in the third quarter of 2004 and up 60 percent from the fourth quarter of 2003. Earnings per diluted share were 21 cents compared to 18 for the third quarter of 2004 and 13 for the fourth quarter of last year. That is year 2003. Revenue for 2004 increased to 586.7 million up 59 percent from 368.2 million in 2003.

Net income for the full year increased to $100.2 million, or 70 cents per diluted share, compared to 57.4 million, or 42 cents per diluted share, on a split adjusted basis in 2003. Our operating margin improved above expectations to 20.4 percent for the quarter and 20 percent for the full year of 2004. This higher margin was due to the exceptionally strong revenue performance in the fourth quarter and allows us to aggressively reinvest in the Company for continued success in the future. The fourth quarter revenue performance was also partly driven by our customers' desire to complete a number of initiatives, complete the budget by end of 2004. Continuing the trend from the third quarter, the pricing and alignment remained stable due to solid demand from new and existing long-term clients. Previous and ongoing investment in Cognizant's vertical approach to the market continues to be a strong competitive differentiator for the [inaudible] During the quarter, we saw strong growth across all of our key vertical markets. Financial services remained the strong performer with approximately 65 percent year-over-year growth for the quarter. Healthcare grew approximately 55%, and we saw a significant ramp up among manufacturing and retail customers as well, stemming in part from retail CIOs renewed emphasis on using technology to improve efficiency.

The retail industry, as you know, has one of the largest bases of back-office legacy systems that need to be modernized; and the current price points of technology and transformation services offer a compelling reason for a number of migration projects in the retail sector. Additionally, we continue to see in increasing interest in offshore outsourcing from companies in the UK and the continental Europe, and we are receiving a large number of inquiries and [inaudible] from potential clients. During the quarter, our operations in Europe had several key wins for both application development for which demand steadily increased throughout the year 2004 We also hired a new head of European operations, Mr. [inaudible] He came in as the vice president based in Amsterdam. He was previously heading Cambridge Technology Partners, European operations, and this appointment reflects our belief in the long-term growth potential for [inaudible]

Turning to our clients, we added 30 new customers during the quarter, three of which represent strategic wins. This elevates our current client roster to about 233 out of which 48 are categorized as strategic customers. As we have stated previously, we [inaudible] client as one offering the potential to generate 5 to $40 million or more in annual revenues for Cognizant for the long-term. The growth we have experienced across the range of sectors reflected in our strategic client wins. A key to Cognizant's high level of customer satisfaction is our ability to delegate new solutions in service offerings.

Throughout the year 2004, we introduced several services, including our newest offering, testing services. Cognizant Testing Services is focused exclusively on supporting our clients' testing needs through independent validation and verification of the internal software. We're able to provide fully integrated testing and tools at every step of the development life cycle. Many organizations have successfully piloted offshore testing efforts in recent years and have now begun to embrace the service as demonstrated by the fact that testing that person, the fastest growing business within Cognizant on an increasing portion of customers' offshore IT. Our key differentiator in this area is the high level of automation that we're able to achieve through significant investments, in technology testing tools, platforms, and, of course, testing processes. We expect this new service to double its revenue contribution in the year 2005 and have now committed over 1,000 employees to this new key, reflecting our high level of expectations. To date, they have crossed our testing services to about 50 [inaudible] existing customers and expect this number to double by the end of year 2005.

Turning to the infrastructure services, although still a small percentage of our overall revenue, we are particularly pleased with the traction we are gaining in infrastructure services practice, which naturally compliments our software maintenance service. This practice group monitors, manages, and enhances the performance of every element of our clients' critical IT infrastructure backbone, including servers, data bases and e-mail systems. This new service is growing rapidly. We already have [inaudible] clients over 300 staff in this practice. The [inaudible] of infrastructure services, launched in early 2004, speaks to the expanding market that we can serve and clearly displays our ability to anticipate and meet customers' requested new services. Our responsiveness to clients [inaudible] allow us to continue to deepen our relationship with existing clients while maintaining a very strong win rate against our competitors. And Cognizant's unique global delivery model, which features high customer relationship, high customer intimacy, relationship that has been coupled with advanced IT consulting and development capabilities, has led to several complex project wins over the past quarter. A growing number of customers are use the range of Cognizant solutions, including application development, integration and management, management of infrastructure, testing business, and technology consulting, and so on. These high-value transformation services are [inaudible] using our business technology consulting, advanced solutions, and domain and technology experts. A recent example is our successful relationship with the large savings and loan institution. Where Cognizant is helping to provide support for development, maintenance of their core applications, including loan origination, loan underwriting, and some of the back office applications like People Soft and [inaudible], and so on.

Turning towards the internal organization, Cognizant remains an employee of choice and the resulting quality of Cognizant staff at every level [inaudible] aspect [inaudible] association. The high caliber candidates that we attract and bring technologies to and business domain knowledge, further separating us from the competition. Our [inaudible] this year included a substantial number of advanced architects and [inaudible]. In addition, in 2004, we hired the largest number of MBA graduates in our history from leading business schools, a total of 420 in both the U.S. and in India, more than doubling the number of business analysts among our staff. In addition to Cognizant's 14,000 qualified software engineers, one in about 30 Cognizant employees now holds an MBA degree. The MBAs we hired earlier in the year have completed the training and are already making valuable contributions to Cognizants expanding service offerings. On a similar note, more than 50% of our employees have completed advanced technology and management-training courses at Cognizant Academy, and in December 2004, we logged our 1 millionth hour of training in the Academy. We believe that our in-house training through the Cognizant Academy is second to none and a [inaudible] tool to our continuing success. To ensure Cognizant meets the future demand requirements of our expanding business, we increased total staff by 10 percent on a sequential basis adding more than 1300 associates during the quarter. We closed the year 2004 with just over 15,300 employees. This overall head count is slightly above the 15,000 we projected last quarter and well above our estimates in early 2004. In 2005, we aim to finish the year with over 22,500 employees, an indication of the confidence we have in the long-term nature of the demand that we see for IT services.

Keeping pace with our growing staff, we also remain fully on track with our expansion plans for the Techno-Complex construction program in India. These new facilities will include 830,000 [ph] square feet of space to house 9,000 developers in [inaudible], Calcutta, and [inaudible] In addition, the expanded program includes 100,000 square feet of education space for use by Cognizant Academy in [inaudible]. Work on these expanded facilities is already underway with the first of the facilities expected to come on line in Quarter 2 of 2005. As the new facilities reach capacity, they're expected to generate significant annual operating savings compared to the use of leased facilities.

And as most of you are probably aware, Cognizant was added to the Nasdaq-100 Index at the end of the fourth quarter, a substantial achievement. We are the only IT services firm on the list, and we're the firm - - and only offshore firm to be included in the Index. The inclusion in the Nasdaq-100 Index is a clear indication of the strength of our global model and a total validation of Cognizant's leadership status amongst traditional and offshore IT services [inaudible].

In closing, our fourth quarter proved better than expected, finished a record year for Cognizant. A biplane of new business remains robust, as customer-interest levels continue to increase, and we have broadened and deepened the nature and scope of our client relationships. We exceeded financial expectations, secured new strategic clients, and our expanded business offerings allowed us to double up stronger relationships with existing customers. Cognizant enters 2005 in our strongest position ever. We remain dedicated to building on this foundation and anticipate continued industry leading performance for the remainder of 2005. With that I'd now like to turn the call over to Gordon for a more detailed look at the financial performance and guidance going forward. Thank you. Gordon?

Thank you, Lakshmi, and good morning to everyone. I would like to provide some additional information on the fourth quarter and full year 2004 and then discuss our financial expectations for Q1 and full year 2005. Revenue for the fourth quarter once again 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 2003. In addition, we experience some clients accelerating the start of planned projects or the completion of a project in Q4 to utilize remaining 2004 budget dollars. As Lakshmi mentioned revenue grew 11 percent sequentially, and 60 percent year-over-year. Our core business remains solid and performed well and our pipeline is robust. For the quarter, application management represent 52 percent of revenue and application development integration the remaining 48%. Both services grew in the fourth quarter. On a year-over-year basis, application management grew 47%, and application development and re-engineering grew 77 percent during the quarter. On a sequential basis, development grew faster than maintenance for the seventh quarter in a row. Application management grew 9 percent sequentially, and application development and re-engineering grew 13 percent driven by the trends mentioned earlier. On a full year basis, application management represented 54 percent of revenue, and application development integration, the remaining 46 percent, growing 46 and 79 percent respectively.

The largest growth driver in the fourth quarter in terms of gross dollars was financial services, which includes our practices in insurance, banking, and transaction processing. It grew $12 million sequentially and represented 50 percent of revenue in the quarter. Retail manufacturing and logistics was our sequentially fastest growing segment in percentage terms, growing by approximately $5 million or 20 percent sequentially and representing 19 percent of revenues. Healthcare grew about $2 million and represented 20 percent of revenues, and information services was 6 percent of the total. The remainder of our revenues came primarily from other services oriented industries as well as our alliances. During the quarter 87 percent of revenue came from clients in North America, as we continue to see an increasing interest level in Europe through offshore services both from the European division from our global clients as well as the increasing number of local clients. European revenue was 12 percent in the total in the fourth quarter.

We added around 30 new customers during the fourth quarter. Our active customer based increased to 233. During the quarter, we were selected as the offshore partner in three accounts, which we consider to be strategic and have the potential to become significant revenue sources for us in the future. We ended work for 15 clients during the quarter, almost all of which were very small clients, when combined generated only about $1 million of revenue in all of 2004.

Turning to costs, costs of revenues increased 62 percent for the quarter, as compared to the fourth quarter of 2003. The increase is almost entirely due to additional technical staff both on site and offshore required to support our revenue growth. We increased our technical staff by approximately 12,050 people during the quarter and ended the quarter with over 14,200 technical staff. This is an increase of approximately 5800 staff for full year 2004.

Gross margin was 45.2% for the quarter, a decrease of 36 basis points compared to the third quarter of 2004 and a decrease of 61 basis points compared to the fourth quarter of 2003. During the fourth quarter, we further increased our bonus accrual to a level well above 100 percent and above the payout levels accrued in Q3 of 2004. This increase resulted from the significant increase in our expected full year performance compared to our expectation just a few months ago. We are pleased to have the opportunity to share a portion of the success with our employees. On a full year basis, gross margin was 45.5 percent during 2004. SG&A expenses, including depreciation, were 42.9 million, up from 28.2 in the fourth quarter of 2003. As a percentage of revenues, SG&A was 24.8 percent in the fourth quarter, down 125 basis points from the fourth quarter of 2003, and down 90 basis points sequentially from the third quarter of 2004.

During the quarter, we continue to strengthen our [inaudible] of expertise and we aggressively hire client partners to manage and grow our customer base, a key differentiator for Cognizant. In addition, we continue to expand operations in Europe to position ourselves for the emerging opportunities in that region. Due to our strong revenue expectations for 2005, we are currently aggressively further accelerating our SG&A spend to differentiate Cognizant in the marketplace.

Operating [inaudible] for the fourth quarter increased 65 percent to 35.3 million, up from 21.4 million in the fourth quarter of 2003. And our operating margin was 20.4 percent, which was up 55 basis points sequentially and up approximately 65 basis points compared to the fourth quarter of 2003. During the fourth quarter, we exceeded our target operating margin goal of 19 to 20 percent. This resulted from stronger than expected revenue during the quarter. We expect to return to our targeted operating margin range during 2005 as we further accelerate our reinvestment strategy. Interest income for the fourth quarter increased to $1.5 million, compared to 770,000 in the fourth quarter of 2003. Interest income increased due to our higher global cash balance and an increased portion of that balance hold in foreign currencies, which earned slightly higher interest rates. We had a 117,000 foreign exchange gain during the quarter, resulting primarily from the impact of the appreciation of the Indian Group E on our net monetary assets in India. Our tax rate for the full year 2004 was 17.9 percent. This is down from our prior expectation of 18.3 percent at the end of Q3. During Q4, our tax rate was 17 percent in order to do a year-to-date catchup to bring the full year rate down to 17.9. As you know, a portion of our tax holiday expired in early 2004 related to our earliest development centers in India. The decline in the tax rate for 2004 was due to, in part, to the higher forecasted revenue, which resulted in smaller percentage of our overall revenue being impacted by the expiration of the tax holiday.

Turning to the balance sheet, our balance sheet remained healthy. We finished 2004 with over $314 million of cash and short term bank deposits, an increase of over 44 million compared to September 30th. Q4 cash flow was positively impacted by the increased level of accrued bonus liability, a slight sequential decline in DSO, and the proceeds and tax benefits on the exercise of stock options. During the fourth quarter, operating activities generated approximately $50 million of cash. Financing activities, primarily the exercise of stock option, generated an additional 13 million of cash. These amounts were partially offset by $25 million in capital expenditures, including expenditures on our India construction program. In addition, we generated $4 million of cash due to currency translation adjustments. Our collection - - our collection of trade receivables during the quarter was very strong. Based on $110 million on December 31st, we finished the quarter with a DSO, including unbilled receivables of 59 days. Excluding our build receivables, our DSO it was approximately 51 days for the fourth quarter. The quality of our receivables portfolio remains very strong. Our unbilled receivables balance is approximately $14 million at the end of the fourth quarter, down $3 million from September 2004. The decline in unbilled receivables resulted primarily from the timing several of several billing milestones, partially offset by volume associated with our strong sequential growth. During the fourth quarter, overall 25 percent of our revenue came in fixed price contracts, up from 23 percent in the third quarter of 2004, and down from 27 percent in the fourth quarter of 2003. When we look at the mix by solution type, during the quarter 28 percent of our development revenue and 21 percent of our maintenance revenue came from fixed-bid contracts. For the full year , 24 percent of revenue came from fixed-bid work.

Turning to head count, at the end of the fourth quarter our worldwide headcount, including both technical , professionals, and support staff, totaled 15,325. This represents a net increase of approximately 1360 people during the fourth quarter, and over 6,000 for all of 2004. Over 50 percent of the net additions were recent college graduates who will enter our training program, and the remaining were lateral highers and experienced IT professionals. Based on our 2005 revenue expectations and our ongoing success in recruiting, we now expect to finish 2005 with at least 2 - - 22,500 employees globally. Turnover, both voluntary and involuntary was 13 percent annualized during the fourth quarter. For the full year, our annualized attrition was 14%, in line with our previously stated long-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, the attrition is heavily weighted toward the most junior members of our staff. Going forward, we continue to target attrition rates in the low teens, in line with historic levels. On-site utilization was around 87 percent for the quarter. Offshore utilization, excluding recent college graduates who were in our training program during the quarter, was around 68 percent. Including trainees, offshore utilization was approximately 57 percent for the quarter.

I would now like to comment on our growth expectations for the first quarter 2005 and for the full year. We are projecting revenue for the first quarter of right around $180 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 for well over 90 percent of our first quarter revenue guidance. We expect an accelerating revenue pattern within Q1, as clients finalize their 2005 budgets during this quarter and release new projects to us for 2005. Although this pattern materially mutes overall quarterly sequential growth in Q1, it results in very strong momentum coming out of Q1 and into the remainder of the year. For full year 2005, based on a strong demand environment for offshore services and our favorable experience on ramp-up rates, we now expect revenue to top 845 million. As has been typical in prior quarters, we expect the majority of our growth in 2005 will come from the ramp up of clients won over the past few years. During 2005, we intend to continue to closely monitor our spending and expect our margin will be in the 19 to 20 percent range, in line with our historic margin levels 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 ability to deliver EPS of 21 cents in Q1. This guidance includes anticipation of a Q1 share count of approximately 146 million shares, a tax rate of 17.9 percent operating margin, slightly above the midpoint of our guidance range 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 96 cents. This guidance includes the anticipation of full-year share count of approximately 148 million shares. In addition this guidance assumes a tax rate of 17.9 percent operating margin, slightly above the midpoint of our range and the absence of further nonoperating foreign exchange gains and losses; and as we mentioned in our press release, this - - all this guidance excludes any impact from the potential expensing of stock options in mid 2005.

Duirng 2005, we expect to spend approximately $79 million on capital expenditures. This is up from $47 million in 2004. Of the 79 million we expect to spend this year, approximately 52 million is related to our current construction program to build close to 1 million square feet in India. The remaining 17 million is for hardware, software, and fit out of leased facilities in India and China. 2005 is the peak expenditure year for our current construction program. We expect the vast majority of our Q1 growth to come from existing clients, particularly the numerous strategic deals that we've won in the past few years. Based on the feedback we have been receiving from these clients about their intention to leverage offshore, combined with the strongest pipeline in our history, we are quite optimistic about the outlook for 2005. Now Lakshmi and I would like to open the call for questions. Operator?

At this time I would like to remind everyone, in order to ask a question, please press press star then the number 1 on your telephone keypad. We'll pause for just a moment to compile the Q and A roster. Your first question comes from Adam Frisch with UBS.

Thanks. Can you guys hear me?

Yes, Adam

Okay. Great. As always nice quarter, and I [inaudible] to say that, but I just wanted to ask you a couple questions on, first the extent of the spending slowdown at some of your larger clients that may be maturing. Obviously your growth forecasts are extremely bullish here on your business, but can you talk about how the new clients might be mitigating some concerns that some clients might have about the growth of the larger existing clients?

Sure thing, Adam. It's a natural part of the cycle. As clients become very large, by definition their growth rates are eventually going to slow. It's just the law of large numbers. The key here is, do have enough clients in the, what I call the hyper ramp-up phase to - - to grow a lot faster than company average. And this is a place where we are very fortunate. We've won so many strategic clients over the past couple years, and these clients take several years to ramp up. So coming into 2005, we have more strategic clients in the ramp-up phase than we had in prior years. So as the large clients, on a percentage basis their growth slows, even though on a dollar basis they continue to grow at healthy rates. The newer strategic clients that are in the hyper-growth phase are the ones that step in. We've gone through this cycle several times through our history. It's normal evolution and fully baked into our plans.

Okay. And in the past, Gordon, you've talked about growth ranges of 30 to 60 percent, and you really don't want to get above 60. If the organic growth slows a little bit, and I say this with a fair degree of sarcasm, slowing to like 45 or 50 percent, in that range, does that increase your appetite for acquisitions, because I was noticing on your balance sheet, not necessarily new, but it kind of snuck up on us, quite frankly, that your cash balance is almost 300 million. So what do you do with that?

Having a healthy balance sheet is very important in this industry, especially as with this new breed of strategic customers we're winning. They're moving a significant portion of their IT requirements to us, which means they want to know we're going to be around for the long-term. When we were dealing with smaller customers, and a large deal was $10 million a year, having $100 million on the balance sheet was plenty. Now that we are dealing with clients who want to grow to many multiples of that amount, we want to have a healthy balance sheet, not because we need to use the balance sheet to buy assets, or anything like that, but it just gives the client a good feeling of security that we are a long-term player. So our strategy is to continue to strengthen our balance sheet. You know, our - - on acquisitions, I don't think our growth rates one way or the other would impact our view on acquisitions. You know, our strategy is to look at fairly small acquisitions that meet very specific technology requirements, to strengthen industry presence, or to strengthen geographic presence. You know, obviously we're very selective in what we do there, but we continue to look and we're optimistic that as you go forward, we'll continue to find small things.

Okay. Great. And then one last question on [inaudible] compliance. I notice there was a paragraph on the press release about it, saying that , I guess your orders are looking at it now. But the statement [inaudible] you know we're not sure what the 10-K is going to have on it relative to this. Is that just normal course of disclosure? Or is there something that we should be expecting to come out of there?

Yes, Adam, this Sarbanes stuff is new. It's unchartered waters for all of us. The way the process - - Sarbane's process is structured, you can't know that you're done until you are done; and let me give - - start give you a real simple example. When we give our Form 10-K to our auditors to review prior to issuance, if they find an error on one of the tables on the footnote - - footnotes, even if we fix it prior to issuance, it's still considered a deficiency ; and then they have to go evaluate the significance of that deficiency. So there's just no way to know you're done till you're done. So we put that disclosure in to make sure everyone understands. You know, until that 10-K file is - - you know, it - - it's not done.

Okay. Okay, guys. Thank you.

Thanks, Adam.

Your next question comes from Joseph Vafi with Jefferies and Company.

Hi, gentlemen, and good morning. And great results as usual. I have a couple of questions here relative to the kind of evolution of the marketplace in terms of your customers. I know, Lakshmi, you mentioned, you know, growth and managed services for example. How are clients potentially dealing with, you know, the issue of having, you know, maybe a traditional IT outsourcer as an IT vendor, doing, you know, some work related to infrastructure and managed services, but at the same time, you're trying to grow that business. And how do you reconcile bumping into them relative to, you know, potentially their contract obligations in that type of work?

Yes, that's a - - that's a good question, Joe. You know, the -- the way the different market sequence and the customers look at is very different. The large customers tend to look at the infrastructure management in a very different way compared to some of the mid-sized customers. The large ones would typically want to, you know, do a - - go through the asset purchase and completely outsource it; but if the mid-sized ones would want some services for [inaudible] the infrastructure that they have. So the way we approach it is, for the mid-sized customers way, we can provide comprehensive solutions, which have great synergy, like the application management [inaudible] infrastructure. That's a good platform - - platform for us to offer cost-effective solutions. That's the key driver for our infrastructure outsourcing services. Having said, in some of the large customers, where there is a synergy, in terms of the application [inaudible] as well as infrastructure management. [inaudible] the hiring activities, we provide those services. But the - - the longer-term way of looking at it would be, we believe that large customers would partner with multiple vendors, each one specializing in their own area. Perhaps they would partner with us for all the applications [inaudible] maybe partner with a strong infrastructure provider for the infrastructure outsourcing services, and so on.

Okay. Okay. That's helpful. Just another question here on the development side. Now, you know, continued you know, outpacing the growth there and clearly development numbers growing faster than maybe traditional, you know, consulting systems integration players, do you have any color here on, you know, is the - - is the demand just, you know, that this higher level of demand being driven by just, you know, costs, you know, cost comparisons versus traditional vendors? Are you seeing more of a - - a share shift as - - as -- - as Cognizant and other Indian vendors really kind of continue to grab share on the discretionary side of the budget?

I would say the way to look at this a little more on the discretionary side, and let me give you a couple of examples. When we talk about development, it includes both green fee projects, as well as what we call migration work, [inaudible] you know, any systems prior to the 1995 area. 1995 we would consider legacy [ph]systems. They got a new lease of life during the Y2K conversion period. Now, many of the customers are looking at converting these legacy calls into [inaudible] black bonds. It's viable now because the technology prices have come down. And more importantly, the services that are required to convert these legacy systems into the current black bonds are viable. They can be done on an offshore basis because of its - - the prices are very, very attractive. So a significant part of the application development that you see, is not true development like from scratch, but a lot of migration work. And that's where the - - the offshore players have a significant advantage, one, the cost reasons; two, the investment and technology and tools that automate the process; and we would just all sort of reflected in the, you know, the greater level of testing requirements, because testing is, you know, as many of these get converted, they need to get tested before they're deployed. So you see a huge ramp up in testing site [inaudible] So double up [inaudible] of the old continued platform.

Right and then one more question, you know, in terms of the investment spending and - - and marketing and sales and - - and the like. I mean, we're talking about a big bump-up in investment spending to bring the margin back down. It might be competitively sensitive, but is there - - is there anything you can share with us that, you know, where - - where you might be spending in new ways or - - or new and new ways that you haven't been spending where this money might be going?

Yeah, the - - under the - - the [inaudible]. The type of engagement that we get into, particularly some of the complex assignments and marketing engagements require setting a high level of architectural skills, a very high degree of program management skills, system integration skills, etcetera. We chart areas that we invest ahead of time, in terms of breeding that capability so that we can play in that space and win some projects [inaudible] And these people would remain in the organization, you know, continuing to work on similar type of engagements where the investments have been made up front. That's primarily the way of the dollar [inaudible] These are typically architects program managers and client partners, who manage multimillion dollar engagements. Gordon, you want to add anything to that?

Sure, just a couple of things, Joe. We're also investing for geographic expansion. We're opening up a development center in China, and obviously that - - that 's - - there's a lot of infrastructure related to that, and Continental Europe, as Lakshmi mentioned, we - - we hired a very senior person to head that up. And so we're going to be expanding our footprint in additional countries and just in our core infrastructure, in such things as, we're significantly expanding our training budget at a much faster pace than overall growth in 2005, because we know there are tremendous long-term benefits in staying well ahead of the curve in areas like training, in HR, in systems, and so forth. So the goal is, we want to try to stay ahead of the curve in terms of being able to support the growth.

Thanks so much.

Your next question comes from Julio Quinteros with Goldman Sachs.

Hi, Julio.

Hey, good morning, guys. [inaudible] I'm sorry?

Yes, go ahead.

Sorry. Real quickly, can you just review the stats that you gave us for the first quarter? I just want to make sure I have got the data that you gave for first quarter on the tax rate, share count, etc.

Certainly. Tax rate both - - our expectation right now, both for first quarter and full year, is 17.9 percent.

17.9? Okay.

17.9, and we're assuming Q1 share count for EPS calculation of 146 million shares.

146.

146.

Okay, great. And then now for the first quarter, the - - the guidance suggests about 4 percent sequential growth rate. Can you just give us a little bit of color in terms of the deceleration versus the last couple of quarters of what we've seen there? Plus, also, what are you - - what kinds of assumptions are you making for utilization, including trainees for the first quarter?

Sure. The - - the deceleration sequential growth is being driven by two things, Julio. First of all Q4, obviously, is very, very strong. And part of that was clients saying, hey, you know, I want to use up my 2004 budget money. Let's get some of this work done sooner, or let's kick off a project that - - normally they would have kicked off in 2005. Let's kick it off in 2004, so at least they can get some of tit under their belt So some of that got pulled into 2004. Then in Q1 of 2005, and you know, we're clearly seeing that this quarter is, you know, January tends to start off fairly slow because people are still finalizing their budgets, figuring things out. What we're seeing, though, as we are looking out to what - - what looks - - what February, and more importantly March looks like, it looks like a lot of stuff is kicking in, you know, right about now, or in March. So, obviously, we don't get the full benefit of that in Q1. We get very little of the benefit, but it sets us up for very healthy growth in Q2. And you have sees that in the last past couple of years in the numbers Q1 versus Q2. And, I think it's going to be a little bit more exaggerated this year, and part of it is because Q4 was so strong.

Okay, and what about for utilization assumptions then for onsite and offshore in Q1?

That - - on-site utilization tends to be pretty steady, because our business model is - - you know, we - - we tend to keep our bench offshore in India. Utilization offshore, a lot of that will depend on exactly where hiring ends up for the year, and in the financial impact of - - in the overall financials, whether utilization is up or down a little bit offshore, really it does - - doesn't matter that much. The key is, do I keep on-site utilization fairly constant.

Okay. Great

Julio, just be clear. The - - I want to make sure everyone understands this. The - - the - - in Q1, because some of the Q1 revenue spilled into Q4, and this was a time that when people locking down their budgets, you know, we certainly do expect a deceleration. But we - - we then expect to benefit from a lot of that as we go into 2000 - - into Q2; and that's one reason why you're seeing us give - - even at this point, giving the quite optimistic outlook for the year. It's based on the stuff clients are saying. Hey we're starting that in March, we're starting that in April.

Okay, great. And can you just run through the - - the normal metrics that you would normally give a percent on-site, percent offshore, for effort mix, average bill rates, utilization, etc, just so we can get those pieces updated in the model?

Sure. [inaudible] Not huge changes. Roughly, on-site, offshore ratio is around 27-73. Billing rates were essentially flat with last quarter. Realized going rates. On-site - - on-site utilization ran about 87 percent, offshore about 57 percent.

What about on the - - just on the client concentration mixes percent of revenue from a client top five, all of the other metrics that you normally give.

Sure. Top 5 clients were 37 percent. Top 10 clients were 50 percent of revenue.

Okay. Great. Thanks.

Thanks, Julio.

Your next question comes from Pat Burton with Smith Barney

Hi. Congratulations on the quarter. My question has to do with your guys moving into the BPO field. You had an announcement out this quarter of some of your initial projects. Could you maybe talk a little bit about that, please?

Yes. On the BPO front, our strategy has been to focus on what we call the vertical BPO, which this business-process outsourcing and the back-office processes that are closely aligned with the application services that we provide, number one; and number two, that requires certain higher level of expertise in terms of domain, technology, and process, and not the horizontal BPO like accounting, [inaudible] and things like that. So we're seeing that strategy and the last six months, we see some traction - - I would say some level of interest in the part of many of the customers to exclude that area where they want to align with an IT partner to do high-end vertical outsourcing work. One of the examples that we announced recently was one such vertical initiative. This is in the pharmaceutical industry. This is - - this is exactly the type of vertical BPO that we've been talking about, that we've been going after, where we can use the combined skills off the technology specialists that we have, plus domain expertise that allowed to be specifically [inaudible] for this and work in the collaborative manner with our partner to build the BPO capabilities. We believe that there is a significant opportunity as we go forward in this BPO area, and this is something that we will focus on. This is not a really large volume BPO, like, you know, there is technically quite thousands of people running calls and there are thousands of people sitting and entering data. This will be a much smaller in terms of margin. I mean much smaller in terms of volume, right in line with the fact that what could we do in terms of margin and capability.

Thank you. And as a follow-up, Gordon, the rate of CapEx growth in '05, would you expect that to - - to slow as the year comes to an end, given the amount of capacity you're - - you're adding to the business?

You mean, do I expect the rate to slow in 2006?

Yes.

The answer is, I don't know. It - - it really depends on what we think 2006 is like and whether we have to kick off yet an additional construction program. Based on our current construction needs, which give us capacity well, you know, well into 2006, the answer would be no, it would slow. But there certainly is a likelihood that, you know, if the business keeps growing at a very healthy pace, you know, we'll have to launch additional construction programs.

Okay. And that's the underlying reason for the 70 percent CapEx growth this year, is the underlying business, obviously.

Yes, and very specifically our move towards owned facilities. Of - - the 79 million, 52 million of it is directly related to the fact that we're building our own facilities instead of leasing.

Thank you.

Your next question comes from James Friedman with Fulcrum Global Partners.

Hi. Thank you. It's Jamie Friedman at Fulcrum. Just to follow up on those same sequence of questions, Gordon, is the increasing CapEx the reason that the goodwill went up to 9 million to 6 million in the quarter?

No. Hi, Jamie. No, not at all. That - - that's results from an acquisition we did in Europe once we did the final purchase accounting for it. Some of the - - we originally had put some of the intangibles into a long-life intangible asset, and the - - the study came back and said it should be goodwill, so that - - that was just a reclass.

Okay. And then, I think, occasionally you'll break out what the percentage contribution from the UK specifically was. Did you mention that on this call?

I did not. Hang on one second. UK was approximately 9 percent of revenue.

Great. And then, let's see. The last question and then I'll pass the baton. Lakshmi, you had mentioned where you were with regard to Phase 2 expansion. If you could just repeat where you are in terms of the timetable for the second quarter, I think you mentioned a facility, and what, you know, the sequence will be across the year.

Yes. Some of the facilities that are coming on stream in [inaudible] we have a couple of construction programs that are going on, one of which will come on stream in the middle of 2005. There is another construction - - the expansion program that's going on in Puna, that is likely to come on stream towards Q4 of this year, and another expansion in Calcutta that is going on will come on stream around Q3 of this year.

Great. Thank you very much.

Your next question comes from Sandra Notardonato with Adams Harkness.

Hi. Thank you. A couple of questions. Can you tell me what the average engagement size is for the strategic clients, what you're expecting in '05 and what it was in '04?

It's - - it's a tough question to answer, Sandy. First of all, to - - at the project level, one customer with the exact same work, one customer may view it as one project versus another customer may break into many projects. There's a huge range of the - - what do we have now ? 40, I think 48 strategic clients. Everything from, you know, one client who's over 10 percent of revenue, to another one of those clients who's, you know, generating, you know, $100,000 of revenue right now. So it's right across the spectrum.

So is there any way to answer the question if you do it by customer, what the average customer at - - that is considered strategic is spending, and what they spent in '04 versus what you expect them to do in '05? spectrum.

I could. I have not done the analysis on that.

Okay.

I can check on that.

Okay. How many client partners do you have now?

Client partners and account managers, we would be probably around 140, 150, that ballpark.

140,150. And if you could break out the revenue on an international basis between application development and application maintenance, that would be helpful.

I don't have it that way. We - - we just track that in total. I can - - offline I can get it to you. That's not something we track.

Do you have a sense of which area is growing faster in the UK or Europe in general?

I would say that in Europe in general the application development grows, - - tends to grow faster.

Okay. And what do you think is driving the growth that you've now seen for the last few quarters in Europe? Some of the other companies haven't ,smaller companies, however, have not been seeing the same time of growth in that market.

The general reason why the development work in Europe - - in Continental Europe is growing is primarily because of, again, [inaudible] of technical talent there. That's the primary reason. In fact, the traditional - - the maintenance work they have in-house staff that they continue to work with. It's more some of the in-house development that used to happen earlier. Now they're outsourcing without having to hire people [inaudible]

Do you expect them to keep the application maintenance in-house, or do you expect that to be outsourced?

Right, they - - some of the older ones they tend to keep it in-house, but some of the newer applications that are being developed like third parties like us, they are - - we have a good shot at doing the maintenance as well.

Okay.

And, generally the - - the clients prefer to outsource that maintenance also instead of transitioning it to the in-house staff.

Okay. And my - - and my last question is around the processes that you may need to put in place to ensure continued customer satisfaction levels as you have to add more and more people to make gross numbers.

Absolutely. I mean, that's - - that's the - - that's the biggest talent that we have in terms of maintaining the culture in the organization, maintaining that customer intimacy. The type of things we have to do is to make sure that we get the right people in. Make sure that like-minded people are hired for the organization, so that's a fairly heavy exercise; and that's something that we think that we are on top of, based on what we were able to accomplish last year. And the second one is the - - the training programs that we have internally with the organization, in terms of not just the technical training program, but the leadership and the management double up in programs that we put our people through in order to make sure that the focus on the customer is [inaudible] And, finally, the most important thing is listening to the customer. You know, it's just about three or four weeks back we had our largest Cognizant community ever, where we got all customers together and had an interaction with them, with our senior management team to see how things are going and whether we are able to maintain that intimacy that we had when we were a small organization, and so on. So there - - there are a number of efforts that are underway to maintain that kind of relationship, and we want to come out stronger, [inaudible] as the leading outsourcing of the service provider, with the greatest customer satisfaction.

Great. Great. Thank you. Great quarter.

Thank you, Sandy.

Your next question comes from Andrew Steinerman with Bear Stearns. Good morning, Lakshmi.

My question has to do with price. My recent trip to India, I didn't hear a lot about pricing moving up despite, you know, that we're talking about, a very, very strong demand environment. Gordon just mentioned flat pricing for Cognizant in the quarter after up pricing in the third quarter. My question is about pricing in 2005. What's Cognizant's philosophy about balancing growth, you know, how fast you could possibly grow with price? You know, how important is it that we get paid full value for the services that we deliver?

Absolutely. Pricing is something that we constantly review, and particularly in many of the new deals that we bid for, comparison it's purely based on the value [inaudible] of declines. The indication of the average price is - - is not really a - - a key criteria to look at, because it is, you know, we have a significant number of old contracts that we have that we continue to perform; and there are certain volume related pricing that we agreed to, and so on. So that's - - that's not really the key factor. But the - - some of in new deals that we get into, particularly the ones that we work in complex engagements, the group that our Business Technology Consulting and [inaudible] Solutions group work on. They tend to come in at a higher price, and they tend to be at a - - they tend to be fixed-price leads, so you know, we try to price all the deals that we go after against value, not based on a rate cut.

And in terms of clients, are you seeing clients pushed back on price, or do they accept that value proposition?

You know, many of the instances, they accept the value proposition. And if the value proposition is sound, in many of the instances they accept that. It also depends on the quality and the category of people that are provided these - - in these engagements. These are high end, top-notch people, there's no question about it.

And just to square my exact question away, would you be willing to sacrifice a couple of points of growth to be sure that you're getting paid full value?

It's depends - - Andrew, it depends on your definition of fair value. If it's, you know, very generic maintenance work, I can do 95 percent offshore. I can do that at a lower rate and still make great margins.

Right.

So, yes, we, you know, we're committed to a business model where we stay in a 19 to 20 percent operating margin level.

Right, but are you also committed to your gross margin?

Gross margin bounces around. You know, you know, as you can see it's, you know, overall it's remained relatively steady, but in the end we run the business to an operating margin level. But, you know, let me be clear. You know, we're comfortable with what we're seeing on pricing. It's not - - it's not something that's keeping us up at night.

Right. Me, too. Thank you so much.

Your next question --

Operator, I think we have time for one more question.

Okay. Your next question comes from Moshe Katri with SG Cowen.

Thanks. Guys, good quarter. A couple of follow-on questions very briefly here. Looking at visibility for 2005, you said, you know, you have 90 percent visibility for Q1. Are we basically at - - looking at your existing pipeline, you know, 70 percent visibility for '05. then you - - you spoke a bit about pricing but didn't - - I don't know if you mentioned anything about - - spoke anything about - - you spoke about pricing for new deals during the quarter, whether there's a trend in there or not. And then finally, what sort of an embedded assumption do you have for wage inflation in your '05 projections?

Sure. Thanks, Moshe. Let's start with the visibility. Well over 90 percent of revenue for Q1 is committed. For the full year, we expect a vast majority of our revenue to come from customers who were with us at the end of last year, but certainly all that revenue is not committed yet. You know, we - - you know, we're working on stuff with people and so forth, so part of it is a definition of, are you talking about committed versus just, you know, do you have a sense of who you can get it from? The great thing about our business model is, new customers during the year typically only contribute about 10 percent of revenue for the year. Because you win a customer, it takes awhile to ramp up. So we know where to focus, and we're not spending our days worrying about, is that new customer going to come in to make revenue numbers for the year. It's more can we grow our existing customer base? That is a much easier thing to understand and - - and to predict. Pricing, average price is flat for the quarter. Obviously on a year-over-year basis it's up a little bit. Pricing on new deals, you know, continue to be healthy. I wouldn't say it's runaway price increases, but, you know, it's clearly - - pricing on new deals is higher than a year ago. That gets partially offset by we continue to move more and more towards large customers. So you net it all out, you know, in 2004 our average pricing was up a little bit. You know, once we're done with 2005, my guess is our average price is going to be up a little bit. So I, you know, I kind of view pricing as imbalance. Wage inflation, you know, we're still finalizing exactly what we're going to do, but clearly there will be low double-digit inflation offshore. It looks like it will be low single-digit inflation on-site. You know, that's built into our guidance and our plans.

The low-digit numbers offshore, are these down year-over-year? Because I thought - - I thought in '04 they were kind of - - kind of in the mid teens, or they were kind of flat.

Still - - still finalizing it, you know. It's going to be somewhere in that range. I -- you know, it -- it's not going to be, you know, high teens, whether it's low teens or a little bit below that, you know, we're still working through the exact numbers.

Okay. And then finally, did you mention the number of strategic clients that we have today, not strategic clients, but those that actually reached a maturity phase; and then is, you know, do we think that we're going to get an uptake to that number in '05?

I think we - - at this point , we're saying - - still staying with about 5 strategic customers who are mature. Now, you know, others - - so of the remaining, whatever it is, 43, some are in the hyper-growth phase, some are, you know, in a phase where, you know, eventually they'll mature. But we're feeling very good going into '05 in terms of the base that we have to - - to drive growth of our strategic customers. We still have a lot of penetration opportunity left.

Great. Thanks.

Thanks, Moshe. I see that we've hit the 11:00 threshold, so, you know, we want to be sure to end on time.

Yeah. And thank you very much. Thanks for participating in today's call. Just to let me quickly wrap up and say that 2004 was a record year for Cognizant, and we enter 2005 with excellent momentum, highly skilled work force; and broad business solutions and service offerings will allow us to attract new strategic clients while retaining and expanding our offerings to our existing customers. and finally Cognizant enters 2005 in our strongest position ever and we anticipate continued strong performance for the rest of the year. Thank you very much.

Thank you, ladies and gentlemen. This concludes today's conference call. You may now disconnect.