高知特 (CTSH) 2005 Q2 法說會逐字稿

Good morning. My name is Michelle (ph) and I will be your conference facilitator. At this time, I would like to welcome everyone to the Cognizant Technology Solutions second quarter earnings conference call. [OPERATOR INSTRUCTIONS] I will now turn the call over to Mr. Peter Schmidt of Financial Dynamics.

Thank you and good morning, everyone. By now you should have received a copy of the company's second quarter earnings release. If you have not, please call me in my office at 212-850-5600 and we'll be sure you have a copy.

On the call today we have Lakshmi Narayanan, President and CEO, and Gordon Coburn, CFO, 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'd now like to turn the call over to Lakshmi. Lakshmi, please go ahead.

Thank you, Peter. Good morning, everyone, and thank you for joining us today for Cognizant's second quarter 2005 earnings call.

This morning I'll provide an overview of the highlights of our first fiscal second quarter, going into some detail behind the key drivers to our strong performance and giving a sense of our view on emerging industry trends and their impact on Cognizant.

As usual, I'm joined on the call by Cognizant's CFO, Gordon Coburn. We're also joined today by Cognizant's COO, Francisco D'Souza, who's going to spend a little time talking about our progress in the telecom sector and our work with the integration of Fathom, a consulting business that we acquired earlier this year.

Francisco, as some of you may know, was part of the founding team from the Dun & Bradstreet Corporation and has over 17 years of experience in the information technology industry in both operational and advisory roles. Francisco is a key member of the team that has been responsible for Cognizant's success to date and is a great example of the depth of home-grown senior talent we have here at Cognizant on our management team. After our comments, we will then hand over to Gordon, who will take you through our numbers in greater detail.

On our last conference call I said we believed all the pieces were in place for 2005 to be a very exciting year of strong growth for Cognizant. I'm happy to report that the second quarter has supported that belief as we saw record growth and Cognizant delivered solid performance in our key financial and operating metrics.

We strengthened our leadership position as a highly differentiated provider of IT services, experiencing continued demand across all our vertical practices and service offerings. We also continued to invest aggressively in our people and our infrastructure to maintain our ability to meet customers' growing demands for an ever-evolving set of solutions and management of highly complex, large-scale programs.

In the second quarter we saw 4 key elements or drivers to our performance. Firstly, as we have mentioned previously, many companies beyond financial services are increasingly recognizing the value of broadly adopting offshore-enabled IT and business process outsourcing. As well as another strong showing this quarter by our financial services practice, we saw particular strength in our health care and life sciences verticals, as evidenced by strategic client wins in those industries.

Health care and life sciences are areas of growing strength for us and our vertical knowledge and expertise gives us a real competitive advantage in this space. Our early work with the ERP product of the health care industry, the Facets products, and our exposure to pharmaceutical sales and market research through our work with IMS Health give us the ability to provide business-aligned IT solutions to the health care and life sciences industry.

During the second quarter, we signed one of the largest pharmaceutical companies in the world as a new strategic client. We are very proud to now be partnering with 5 of the top 10 global pharmaceutical companies to provide them with a comprehensive set of business-aligned IT solutions.

Secondly, Cognizant is seeing significant traction in the ERP space and the enterprise business solutions space, specifically in SAP. Our investments in our SAP practice, coupled with our alignment of specific verticals are starting to show promising momentum. Cognizant has also built a unique SAP portfolio analysis model that helps our customers take a structured and scientific approach in identifying areas in SAP more suitable for offshoring.

SAP customers look for a number of quite-specific items from their partners, namely global delivery capabilities for 24 by 7 support, upgrade of mySAP ERP and many are actively looking at the NetWeaver platform to build adaptable and flexible solutions. Cognizant is able to meet all these needs and during the quarter we won a number of key accounts to provide global support, upgrade and custom development solutions in SAP.

Having successfully delivered large, complex e-business applications, we believe we have the platform on which we can build synergistic capabilities on the NetWeaver platform. Our close association with SAP Labs in India on training and other activities on the NetWeaver platform gives us the ability to work on complex system integration and client engagements.

In addition, we've continued to strengthen our solid capabilities in the CRM space, which is rated among the best in the industry.

Thirdly, we have seen increased traction for our high-end vertical business process outsourcing, our vBPO offering, as we call it, and we have continued to build out our strategy and organization in this area. Over the past several months we have begun business process outsourcing projects for clients in the life sciences and health care sectors, addressing high-value process areas such as clinical trials data management, health care claims validation and collection. Our previously announced BPO engagement with Pfizer India has made significant progress and I am pleased to report that we beat the milestones laid out for this engagement.

Over the next several quarters, we anticipate expanding our vBPO presence in the financial services arena, working on client activities such as letter of credit processing, mortgage credit analysis and other back office functions. This is another great example of how we're able to leverage our key differentiators of vertical domain expertise, IT process, joint optimization and high-touch client relationships.

A key aspect of our current and anticipated progress in this area has been the recruitment of a number of experienced senior process managers, including Ramesh Gudlure (ph), who joined us from [inaudible] the [inaudible] in India. Ramesh (ph) successfully led the BPO practice at [inaudible] and now leads Cognizant's vBPO operations. His extensive experience will be a valuable addition as we continue to build out our vBPO solution offerings across additional verticals.

While we are excited by these developments, I do want to remind everyone that our BPO practice is still growing from a relatively small base and while an important aspect of our widening set of IT solutions and already providing good quality revenue, we do not anticipate that vBPO will reach meaningful numbers in terms of headcount or financial contribution until year 2006.

And finally, we have seen robust growth in demand for our business intelligence and data warehousing services. Many of you will probably have seen our recently issued survey, which details some of the drivers behind this area of business.

Our study showed that from 2002 to 2004 the size of our customers' data warehouses grew by 400% annually, as measured by the average number of reports produced per data warehouse. Activity was driven by an increase in demand for data warehousing solutions that enable Sarbanes-Oxley compliance and provide competitive intelligence.

We saw a 40% compound annual growth rate in the number of companies making investments in compliance reporting and a 50% annual increase in companies consolidating stand-alone data marts and business intelligence systems. To take advantage of this trend, we introduced offerings specifically aimed at meeting our clients' growing needs in this area, such as the global reporting shop. This is an integrated service center that offers systems integration and customized, on-demand report generation and delivery services. The growth we have seen in our data warehousing and business intelligence practice has again been driven by Cognizant's investment in the data warehousing technology and the frameworks that we created in our labs, which substantially enhance ROI on our customers' IT investments.

Just to sum up, in the second quarter our expanding client base and our ability to cross-sell new solutions like enterprise business solutions, business intelligence and vertical BPO solutions have been the primary growth engines. On a similar note, last quarter's acquisition of Fathom Solutions, an IT consulting company, has already provided us with a number of additional cross-selling opportunities, particularly in the telecommunications sector.

As I mentioned earlier, I'll now hand over to Frank, who's going to spend a little time talking about our progress in the teleco sector and how the integration with Fathom is progressing. Frank?

Thank you, Lakshmi. We are particularly happy with the growth and progress we have experienced within the telecom sector since our acquisition of Fathom last quarter. As we previously outlined, Fathom Solutions is an award-winning Chicago-based consulting company and it has provided us with the opportunity to offer clients a combination of industry-focused IT consulting with our top-tier onsite offshore model, particularly within the telecom vertical.

Fathom brought several key strengths to us in terms of IT strategy, process design, program management and systems integration. As we announced previously, Jeff Lee, one of Fathom's founders, became North American managing director for our telecommunications practice.

Jeff and his team have already got off to a great start and the expected synergies from our complementary skill sets have already borne fruit. We are actively combining Fathom's traditional strengths in IT and operational strategy and process design and improvement with Cognizant's traditional technology development and systems integration capabilities to propose end-to-end business-aligned IT solutions to customers.

In the telecom vertical, this combination allows us to propose cost-effective solutions to some of the most pressing industry issues such as growing revenue streams and increasing customer loyalty. We have already seen this begin to translate into new clients for our IT solutions offering and deeper relationships with our existing customers in this important, growing vertical.

For example, as a result of teaming with Fathom during the quarter, we were awarded 2 significant engagements in the data warehousing and CRM space by a large residential long distance company in the United States. We expect to see similar opportunities as we continue the process of integrating Fathom more closely into the Cognizant team.

And with that, I'll hand it back to Lakshmi. Lakshmi?

Thanks, Frank. Thanks for that update on Fathom.

Turning to our financial highlights for the quarter, we ended the second quarter with a revenue of $211.7 million, up 17% sequentially compared with $181.7 million in the first quarter of 2005 and up 53% from the second quarter of 2004. Earnings per diluted share were $0.25 compared to $0.22 for the first quarter of 2005 and $0.17 in the second quarter of last year. Our operating margin remained a healthy 20% for the quarter.

The strong demand environment we are experiencing continues to allow us to maintain these consistently solid margins, even while absorbing the impact of a previously announced wage increase, which took effect at the beginning of the second quarter.

Turning to new clients, we continue to be pleased by the number and diversity of our new client wins. We added approximately 28 new customers during the quarter, 5 of which are strategic clients in several sectors, including financial services, retail, telecom and health care.

This brings our current strategic client total to 60. As previously explained, we define a strategic client as one offering the potential to generate between $5 and $40 million or more in annual revenues for Cognizant over the long term.

Financial services, which includes insurance, remained a strong performer with approximately 57% year-over-year growth for the quarter. The growth in financial services market continued primarily through account expansion. For example, we expanded our relationship with one of our large financial customers in continental Europe to offer a comprehensive set of services in some of their front-end applications and we also cross-sold a number of new services to a large UK-based bank.

As I mentioned earlier, health care also had a great quarter, growing by 48% and we saw healthy growth in our other vertical practices, as well.

We have talked a lot about growth in our business and a key reason that we are able to keep meeting the demands of that growth is our ability to recruit and keep top talent. Cognizant continues to appeal to the top graduates and employees within India and around the world, leading to the exceedingly high quality of Cognizant staff at all levels of the organization.

Based on our updated future demand for Cognizant's businesses, we increased total staff by another 13% on a sequential basis, adding more than 2200 associates during the quarter. This increase marks the largest number of hires during any one quarter in the company's history, a great achievement on the part of our HR and recruiting teams.

We also managed to break another record, namely making the highest number of offers to new engineering graduates. Cognizant obtained the top slot, the day one slot in the top engineering university in Chennai and selected over 500 engineers in one day alone.

At the end of the second quarter, we had over 19,250 employees at Cognizant. We currently have more than 20,000 employees and, based on our current growth projections, we expect to finish 2005 with more than 23,000 employees across the globe.

Our commitment to excellence has again been recognized by others as early in the quarter Cognizant was selected as the best U.S. company in India for 2005 and recipient of the first Indo-American Corporate Excellence Awards instituted by the Indo-American Chamber of Commerce. Cognizant won the award based on our financial performance, human capital management, corporate social responsibility and stellar contribution to the Indo-U.S. business. We are proud to have been selected for this honor and will continue to work hard to ensure we maintain this level of excellence.

Also, in May we were ranked in Business 2.0 as among the top 100 fastest-growing technology companies. And finally, we were delighted to be named to “Business Week's” InfoTech 100, a roster of the world's top 100 IT companies, for the second year running.

In order to meet the ongoing growth in demand and reinforce our commitment to maintaining our leadership position, we continue to aggressively invest in the construction of our own training and service centers. This month we opened 2 new technology centers in Mumbai and Coimbatore.

Mumbai, with its proximity to an extensive talent pool of highly skilled life sciences and financial service graduates, and a rapidly growing base of major pharmaceutical companies, is an important expansion for Cognizant. As I mentioned earlier, we are now partnering with 5 of the top 10 global pharmaceutical companies and our Mumbai center will only strengthen our presence within this rapidly growing vertical.

Earlier this month, we also executed an option for an additional 50,000 square feet of office space in Mumbai and, once operational, we will be able to increase our overall capacity within the technology center to over 750 professionals. This will allow us to leverage our proximity to existing Cognizant clients to strengthen these existing relationships while simultaneously expanding our reach to new prospective clients with branch offices located in Mumbai.

Coimbatore is another major university town, close to Chennai, and boasts of 4 of the top 10 engineering colleges in the southern state. It's also an industrial town known for its entrepreneurial culture. As such, Coimbatore is a strong fit and a logical location for one of our technology centers. We have established a facility here primarily to cater to the application management, testing and remote infrastructure management service lines.

In summary, we enjoyed another quarter of strong demand for Cognizant's unique service offerings across a range of industries, building on our leadership position as a premier global provider of outsourced IT solutions.

I'd now 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'd like to provide some additional information on the second quarter and then discuss our financial expectations for Q3 and full-year 2005.

Revenue for the second quarter significantly exceeded our prior guidance due to continued application management ramp up of clients won over the past few years and continued greater-than-anticipated strength in discretionary development spending, a trend that started for us in the second quarter of 2003.

Revenue grew 17% sequentially and 53% year-over-year. Our core businesses remain vibrant and our pipeline is robust.

For the quarter applications management represented 52% of revenue and applications development and integration the remaining 48%. Both services grew significantly in Q2. On a year-over-year basis, application management grew 43% and application development and integration grew 64% during the quarter.

The largest growth driver in the second quarter, both in terms of gross dollars and percentage, was financial services, which includes our practices in insurance, banking and transaction processing. It grew $37 million or 57% year-over-year and represented 49% of revenue in the quarter.

Retail manufacturing logistics grew by approximately $11 million or 43% year-over-year, representing 18% of revenues during the second quarter. Health care grew over $12 million or 48% and represented 19% of revenues. The remaining 14% of our revenues came primarily from over service-oriented industries, as well as our alliances.

During the quarter 87% of revenues came from clients in North America. European revenue was 12% of the total in the second quarter.

As Lakshmi mentioned, we added 28 new clients during the second quarter. In addition, we gained 8 clients through our April acquisition of Fathom Technologies. Our active customer base increased to 246. During the quarter we added 5 clients which we consider to be strategic and have the potential to become significant revenue sources for us in the future. We ended worked for 23 clients during the quarter, almost all of which were very small clients.

Turning to costs, cost of revenues increased 56% for the quarter as compared to the second quarter of 2004. The increase was due to additional technical staff, both onsite and offshore, required to support our revenue growth, combined with the implementation of our previously announced global salary hikes at the beginning of the second quarter.

We increased our technical staff by approximately 2000 during the quarter and ended the quarter with approximately 17,900 technical staff. This was a net increase of almost 7000 from June of last year.

Gross margin was 44.4% for the quarter, a decrease of 170 basis points sequentially and a decrease of 115 basis points compared with the second quarter of last year. Gross margin in Q2 was negatively impacted by the implementation of our annual global salary increases on April 1st, an increase in the low double digits offshore and very low single digits onsite, as well as a slight increase in our onsite staffing ratios as a result of knowledge transfer associated with our strong revenue growth and lower gross margins associated with the 100% onsite model of our recent acquisition.

During the second quarter we continued to accrue bonuses at a level well above 100%. We continue to be pleased to have the opportunity to share a portion of our success with our employees.

SG&A expenses, including depreciation, were $51.6 million, up from $35.4 million in the second quarter of last year. As a percentage of revenues, SG&A was 24.4% for the second-- for the second quarter, down 115 basis points from the second quarter of 2004 and down 125 basis points sequentially. During the quarter we continued to strengthen our vertical expertise and aggressively hired client partners to manage and grow our customer base while benefiting from scale economies associated with rapid growth.

Operating income for the quarter increased 52% to $42.4 million and our operating margin of 20% was flat with the second quarter of last year.

Despite the modest decline in gross margins in Q2, we were able to maintain our year-over-year operating margins as well as remain at the high end of our long-stated operating margin target range. We were able to do this while still investing heavily for growth and to differentiate ourselves from the market place. This was possible due to our strong top-line growth and associated leverage we can capture in SG&A areas.

Interest income for the second quarter increased to $2.1 million compared to $815,000 in the same quarter last year. Interest income increased due to higher global cash balances, as well as an increase in U.S. short-term interest rates. We had a $600,000 foreign exchange loss during the quarter, primarily associated with a decline in the pound sterling and euro.

Our tax rate for the second quarter was 17.8%, in line with our prior guidance, and flat with Q1 of this year. For the full year, we currently expect the tax rate to remain at 17.8%.

Turning to the balance sheet, our balance sheet remained healthy. We finished the second quarter with over $326 million of cash and short-term investments, up $12 million from March 31st of this year.

During the second quarter operating activities generated approximately $31 million of cash. Financing activities, primarily the exercise of stock options, generated an additional $12 million of cash. These amounts were partially offset by approximately $14 million of capital expenditures, including expenditures on our Indian construction program, as well as $14 million towards the previously announced purchase of Fathom Technologies. In addition, we used $2 million of cash due to currency translation adjustments.

Our collection of trade receivables during the quarter was below our expectations and was our only area of disappointment for the quarter. Based on our $165 million-plus balance on June 30th, we finished the quarter with a DSO, including unbilled receivables, of 71 days compared to 65 days at the end of March.

The unexpected increase in DSO resulted from a delay in issuing April and May invoices to several clients while we continued-- while we completed contractual renewals as well as increase in unbilled receivables, which I will discuss momentarily. The quality of our receivables portfolio remains exceptionally strong.

Our unbilled receivables balance was $22.6 million at the end of the second quarter, up $3.9 million from March of this year. The increase in unbilled receivables resulted primarily from the timing of several billing milestones and the volume associated with our continued revenue growth. We expect approximately 60% of the June 30th unbilled balance will bill this month, in July.

During the second quarter overall, 25.4% of our revenue came from fixed-price contracts, down slightly from 25.7% in the first quarter of 2005 and up from 23.5% in the second quarter of last year. When we look at the mix of-- by solution type during the quarter, 30% of our development revenue and 21% of our maintenance revenue came from fixed-price contracts.

Turning to headcount, at the end of the second quarter our worldwide headcount, including both technical professionals and support staff totaled 19,250. This represents a net increase of over 2200 people during the quarter and over 7300 people compared to June of last year.

Approximately 50% of our Q2 hires were recent college graduates who will enter our training program and the remainder were lateral hires of experienced IT professionals. Based on our 2005 revenue expectations and ongoing success in recruiting, we now expect to exceed 23,000 employees globally by the end of 2005 and we are moving along well towards this goal, having exceeded 20,000 global employees just a few days ago.

Turnover, both voluntary and involuntary, was between 16% and 17%, annualized, during the second quarter. Historically, second quarter is the peak quarter for attrition due to the timing of bonus payouts. Attrition in the second quarter of 2004 was slightly above 17%. We continue to expect full-year attrition to be in line with our previously stated longer-term expectations of the low teens.

The vast majority of Cognizant turnover occurs in India, resulting in onsite annualized attrition rates well below the global rate. In addition, the attrition is heavily weighted towards the most junior members of our staff. We continue to expect full-year attrition for 2005 to be in line with our previously stated longer-term goal of the low teens.

Onsite utilization, once again, was around 86% for the quarter. Offshore utilization, excluding recent college graduates who were in our training program during the quarter, was around 65%. Including trainees, offshore utilization was approximately 55% for the quarter. We had approximately 2100 people unbilled in our training program at the end of the quarter.

I would now like to comment on our growth expectations for the third quarter of this year and for the full year. We are projecting revenue for the third quarter of at least $232 million.

We continue to have significant revenue visibility due to our high level of recurring revenue and the long-term nature of our customer relationships. In fact, today we have customer commitments for over 90% of our third quarter revenue guidance.

For the full year 2005, based on the strong demand environment for offshore services and our favorable experience on ramp up rates, we now expect revenue to be at least $876 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 operating margin to remain in the range of 19% to 20%, in line with our historic margin level and prior guidance.

With this expected level of revenue growth and our expected operating margins, we are currently comfortable with our ability to deliver EPS of $0.26 for Q3. This guidance includes the anticipation of a Q3 share count of approximately 147.8 million shares, a tax rate of 17.8%, operating margins within our guidance range and the absence of further non-operating foreign exchange gains and losses.

Based on current business trends, we currently expect EPS for the full year of approximately $1.01, a $0.02 increase from our prior guidance. This guidance includes the anticipation of a full year share count of approximately 147.5 million shares. In addition, this guidance assumes a tax rate of 17.8%, operating margins towards the upper end of our guidance range and the absence of further non-operating foreign exchange gains and losses.

We remain on track to spend approximately $79 million on capital expenditures this year.

We expect the vast majority of our Q3 growth to come from existing clients, particularly the numerous strategic deals we have won in the past few years. Based on the feedback we have been receiving from these clients about their intentions to leverage the advantages of offshore, combined with the strongest pipeline-- sales pipeline in our history, we are quite optimistic about the outlook for the remainder of 2005.

We would now like to open the call for questions. Operator?

[OPERATOR INSTRUCTIONS] Julie Santoriello, Morgan Stanley.

Gordon, I'm wondering if you could comment on the headcount growth. It's been trending rather strong and ahead of expectations in the first half of 2005, growing over 60% year-over-year, ahead of the revenue guidance. I wonder if you could help us reconcile the difference between those 2 and what-- what that may mean, if you need additional people in the lower ranks to support the existing projects and existing growth or if we should look at that as more of a leading indicator for potential revenue acceleration?

I would think about it in several ways, Julie. First of all, there's some timing differences in there as we continue to focus on hiring college graduates who will be put through our 6-month training program. The-- those hires tend to happen in first, second and third quarter, less so in the fourth quarter.

And, as you know, we like to keep a very deep bench in India. The cost of doing it is fairly-- is fairly low and it gives us the ability to offer a broad range of services and to respond quickly to client needs to ramp up. So it gives us the flexibility so if clients come to us seeking additional services we have the ability to turn on that capability very quickly.

So I would view it as a combination of timing and our bullishness on-- based on the increased guidance we've given for this year and position ourselves for growth in 2006.

Then if I can just get a quick follow-up to that, can you comment on your growth thus far in other regions, especially Europe, how you're growing headcount in that region and what you're seeing in terms of customer demand?

This is Lakshmi, let me answer that question. As far as Europe is concerned, we still believe the growth is ahead of us. We have to look at Europe in two segments. United Kingdom, UK, is tracking more or less on the same lines as the U.S., similar growth. Continental Europe is-- I mean, they're still into the early stages of adoption. So we see some activity there, but we believe that the bulk of the activities will start in the coming quarters.

The hiring that happens is primarily for the U.S. and the UK businesses. As far as continental Europe is concerned, that tends to be a little lumpy. There are some projects that start up, shut down and then take some time for the next ones to start. But we are bullish about continental Europe as well and the hiring that we are doing ahead of time is to meet the expected demands from continental Europe, as well.

Also, Julie, remember we have a very mobile work force. So we're constantly moving people from the U.S. to Europe and India to Europe. So we move the people around to meet the client requirements.

Moshe Katri, S.G. Cowen.

Good quarter. Gordon, may you can provide some more details about the increase in your unbilled during the quarter? That's number one. And then maybe talk a bit about some of the things that you didn't provide in your metrics is the mix from top 5 and top 10 clients, as well? Thanks.

Sure. The unbilled is a combination of two things. Part of the growth was simply-- revenue grew 17% sequentially and part of it is the timing of some milestones where we've started on some bigger projects, the milestones are a little bit more spread out or they hit in July or August.

One of the things that makes us very comfortable with our unbilled balance is the fact that 60% of it bills this month. So it's not like this is stuff that's not going to get billed for many months or many years. It turns over very quickly.

The statistics on the top 5 and top 10 were great. Let me just pull those up for you. Both the top 5 and top 10 grew significantly in dollar terms but continued to decline as a percentage of revenue, which is exactly what we want. So the top 5 customers represented 34% of revenue this quarter and the top 10 customers represented 46% of revenue.

And could you remind us where the numbers were last quarter and then a year ago?

Sure. Last quarter each percentage was 1 point higher. So it was 35% and 47%. A year ago I don't have off hand. It was certainly higher than that.

OK.

And what's happening there, Moshe, is exactly what we wanted. As we have more and more strategic customers, obviously, the more customers are outside the top 5 and top 10, so we continue to diversify the client base while continuing to have growth in the top 2 categories.

And then, if my notes are correct, you've also had a utilization rate uptick-- a turnover rate uptick last year in June and I think it also spiked up to 17%, am I correct? And then it kind of bounced back down?

Yes, absolutely. The spike in Q2 was-- we fully expected that. It's something that happened-- the exact same thing happened last year. We pay out our bonuses in March, so typically you get-- you get a lot of turnover in Q2. So that was not unexpected and, as I said, we expect, based on what we know at this point, to be in the low teens for the full year.

Great. And then last question, any impact from some of the flooding that you've been experiencing in India during the past week or so on your facilities? Thanks.

Yes, Moshe, the flooding has been predominantly in Mumbai City where, as you know, we just recently started our operations. It's a small operation. It was impacted. I mean, this is something that -- for those of you who have traveled to India know. At the beginning of every monsoon we have some destruction. And this time it seems to have been particularly hard hit.

We had some impact in terms of delayed arrival of people, et cetera, but normally what we do is we compensate for the work-- work time lost by working the following Saturday. So that process is in place.

The office facility that we have was not impacted, because it wasn't in the region where the flooding happened. None of our people were impacted. In fact, we were able to offer our office location for some of our customers to move in and work.

So all in all, we're not impacted but we're watching that situation carefully and we also-- that's the reason why we do many of our customer projects in multiple locations and have a good business continuity plan. Should something happen in one location, within 8 to 12 hours we will-- we have the capability to move it to one other location so that important work is not disrupted.

Mayank Tandon, Janney Montgomery Scott.

Good quarter. Gordon, if I could just ask you in terms of the offshore/onsite revenue mix and pricing trends in the quarter?

Sure, Mayank. The onsite/offshore headcount mix shifted a little bit more towards onsite and that was a combination of two things -- the Fathom acquisition, those people, obviously, 100% onsite, and two, with the rapid revenue growth, a little bit more knowledge-- knowledge transfer going on.

Billing rates, exactly what we expected -- stable. Onsite billing rate was up about $1. The primary driver of that was the fact that the Fathom acquisition has higher billing rates. Offshore was up-- was up a couple cents. So the way-- not losing any sleep over billing rates. They were essentially stable to up slightly, exactly what we were expecting.

Just going back to the onsite/offshore mix, can you give us some percentages in terms of revenue and headcount? Even ballpark would be helpful?

Oh, sure. Headcount I can give you. It's 27% onsite/73% offshore. Revenue I don't have handy. Give me a call I can-- we don't track that, so I've got to back into that number.

And can you remind us what the figures were in terms of headcount last quarter?

Sure. Headcount was 26% onsite. So it grew from 26% to 27%.

OK. And then just two more quick questions. One is repeat business in terms of revenue?

Sure. Statistics stayed right in line with what we've been tracking, excluding the Fathom acquisition, obviously. We were just over 90% of revenue in the quarter was from customers who have been with us at least a year. So very consistent with what we've been tracking the last year or so.

OK and a final question, really, for Lakshmi around sort of the large outsourcing deals out there in the market. Some of your competitors have been named in terms of these deals, the multi-million dollar, hundreds-of-million-dollar-type transactions. Is Cognizant now competing on bids like that? Or are you still playing at a level lower in terms of the sub-hundred-million-type transactions out there in the market? Thanks.

I mean, there are-- Mayank, there are a number of opportunities. One of the things that we see in many of these large deals is they pick 2 or 3 partners right up front and work with multiple vendors, right from the beginning. And many of those deals we are participating in and some of those we have won in the last quarter, announced as part of the strategic clients.

Some of the larger outsourcing deals that you hear about, particularly in Europe, tend to be predominantly the infrastructure outsourcing type of deals in which our ability to participate at this stage is relatively limited. But however, going forward, as we ramp up these kind of capabilities, we do expect to participate in some of these larger opportunities, as well. But the application outsourcing, application development deals that we see we are there in most of them.

Pat Burton, Smith Barney.

Congratulations on the quarter, as well. Gordon, could you go through the factors, year-over-year, that influenced the gross margin decline? I assume the sequential decline was the wage increases, but could you talk about on both the year-over-year and sequential basis? Thanks.

Sure. Absolutely. Sequentially it was really two things. It was the wage increase -- that was the big chunk of it -- and also the acquisition, because it's 100% onsite, has slightly lower gross margins, though operating margins are certainly in line with the overall business. On a year-over-year basis, similar factors. The acquisition and also, obviously, wages kicked in. There was a decent amount of wage inflation.

Again, gross margins bounce around, up and down a bit, every quarter. If you look back historically, some quarters they go up, some them go down, based on what's the onsite/offshore mix for that quarter, because as you move onsite it hurts gross margin based on what the pyramid looks like. We give a lot of our promotions in April and then we do some more promotions in October, so you tend to see-- you get hit a little bit and then the pyramid flattens, the following order and so forth.

So gross margins are always going to bounce around a bit.

Would you expect them to improve as we move through the year?

We don't-- we run the business based on operating margins. I would expect some quarters gross margin will go up, some it will go down. We focus the people on customer contribution and operating margins.

Do I see anything that's going to cause the gross margins to move meaningfully one way or the other? I don't see anything that causes it to move meaningfully.

OK and it's fair to say you expect to continue to lever the SG&A absolute dollar costs as you move throughout the year?

Yes, we-- the reason I reiterated that we expect to stay in our operating range, operating margin range, was exactly to reinforce that point. We-- we very heavily overinvest in SG&A and we continue to gain leverage down in SG&A as our new owned buildings come on line, as our account managers, their accounts ramp up. So we feel we have a lot of ability to leverage SG&A.

Julio Quinteros, Goldman Sachs.

I just wanted to check in real quickly on the billing rates. It sounded like you had said that the impact of Fathom has had a positive $1 impact on your onsite bill rates. So you can just talk about your expectation going forward as far as that's concerned? Because now we're looking at an average onsite rate of around $70.50 if my math is right versus what we were last quarter. Can you just talk through that number and where you think the billing rates would go? And it sounded like the offshore rate was basically flattish?

First of all, the offshore rate was up a couple cents, not meaningfully. The onsite rate, I rounded a little bit when I say a buck, but the main movement in the onsite rate was due to Fathom.

Now Fathom is, obviously, in the run rate so would I expect any significant movement in the billing rates? As we've said coming into the year and continue to say, it's a stable pricing environment. On a full-year basis we think average rates will be up about 1.5% or so and that still feels about right to us.

And can you remind me how many people you have in Fathom right now?

When we did-- that's a difficult question to answer as Fathom is quickly getting integrated in, but when we did the acquisition I think there were about 120 employees, somewhere around there.

120.

Not all those were-- there's some support people in there.

OK. And with regards to your CapEx plans for the full year, can you just sort of walk us through what the full-year CapEx plans consist of, again?

Still very much on track to spend the full $79 million. Due to when the buildings are coming on line, it's a little bit back-end loaded in the year, but you should still have $79 million in your model.

OK. And as we begin looking at 2006 here, no I don't want to pin you on an actual number, but I might as well ask now. 40% to 60% still the target into 2006? And what variables could lead to sort of the low end versus the high end of the '06 guidance?

First of all, we have not given any guidance for '06. Historically we only give our guidance as we come into the year. So I'm not sure where those numbers came from.

Your long-term target is 40% to 60%?

We've never-- our long-term target is we expect to grow faster than the industry.

OK.

I think where the 60 is coming from, we've always said that's the fastest we would physically be able to grow.

Got it.

The-- clearly we're winning a lot of strategic accounts and strategic accounts take years to ramp up. So coming into 2005 we had a very good tailwind and based on the fact we've already won 10 strategic accounts in the first half of this year, I think we're going to have a very good tailwind coming out of 2005.

Given the sequential growth in the June quarter, which was-- I mean, it was completely off the charts at 17% here, the sequential guidance in the back half of the year assumes a little bit of a slowdown relative to the type of full-year number that you gave. Can you just talk through what-- what would lead to a deceleration from the current level in the back half of '05?

Sure. If you look at the last couple of years, you saw the exact same pattern. Q2 tends to be our best quarter, by far, because we-- one, it has the most billing days for the year, and two, you get a full quarter of the 2005 budget versus Q1 tends to be a little bit muted. And you saw that this year where Q1 sequential growth was fairly weak, so your baseline that you're growing off of, going Q1 to Q2, the Q1 baseline is fairly low.

But if you look at 2003, we grew 17% in Q2, 12% in Q3. In 2004 we grew 16% in Q2, 12% in Q3. So historically Q2's been the strongest quarter for us.

Yes, that's a good point. OK. And then finally, just in terms of total accounts, can you just run through those total numbers again, total accounts, top 5 and top 10?

Sure.

The percentages that you gave and then the total number of clients.

The total number of clients is 246. Top 5 customers represented 34% of revenue, top 10 customers 46% of revenue.

OK. And I'm sorry, did you give out operating cash and free cash flow number for the quarter?

I can-- hang on one sec and I'll give that to you. Operating cash flow was $31 million. There was $11.8 million from financing activities and investing activities. I'm excluding the movement in short-term investments. But it was $14 million for the acquisition and $14 million for CapEx.

So operating cash of $31, $14 million of acquisition cost and $14 million in CapEx.

Right and $12 million of option proceeds.

Joseph Vafi, Jefferies & Company.

I was wondering-- we've seen from some of the other industry players some increased costs coming from visas. I was wondering if that was baked into the number here this quarter and how that might be affecting Cognizant?

Yes, the visa costs in 2005 are way, way up from 2004, but that was not a surprise. We knew that coming into the quarter-- I'm sorry, coming into the year. We baked it into our budget. I think actually on our Q4 call we actually talked about that as one of the cost factors going way up. The reason for that is there's now a $500 stamping fee on all visas and some of the other fees had expired in 2004 and are now back in place.

So I fully agree with what my competition's being saying in terms of visa costs are way up, but it is not a surprise to us and it is fully baked into our guidance.

And, Gordon, is that baked into the gross margin or the G&A line?

That's baked into the operating margin.

It-- would it be in the cost of services line or in the SG&A line?

The visa fees themselves-- the travel costs are in cost of goods sold, the fees for visa is part of our HR function and that's in SG&A.

OK. And then did you break out how much Fathom was in the quarter?

I didn't, but it was $6.8 million.

OK.

Let me just point something out, Joe. We had-- we overperformed by, I think, about $5 million for the quarter, so $800,000 of that came from Fathom. So $4.2 million of the over performance was from the core business.

One of the things we're very pleased about was Fathom, obviously, continued-- usually right after an acquisition you see a little blip in performance. The fact that they overperformed by $800,000 said they continued to execute very well. It was a very smooth transition.

OK. That's helpful. And then in some of the new-- in some of the new geographies that you're going into in-- I think that's Coimbatore?

Coimbatore, that's right.

Lakshmi, are you going to be building an owned facility there? Or are you leasing? Or what's the strategy and in that city, what's the-- how large of a facility do you think that that city supports for Cognizant there?

We are right now leasing the facility. Our strategy has been to lease the facility for the first few years in any new location and as we build scale, as we experience that location and as we ramp up we then invest in our own facilities in those-- those locations. So Coimbatore will, for the foreseeable future, continue to be a leased facility.

OK. And then just, Lakshmi, another question. You were talking about the BPO strategy of the firm. Could you maybe share with us as you-- as you enter a new BPO offering, as you've been doing, how does-- how does the process work? Are you going to existing clients with an idea and working with them to build it out or are you-- are they coming to you? How is this process working as you kind of evolve the BPO business?

I mean, it works primarily with our existing customers. It works both ways. In some instances, we are able to take a proposal across to our existing customers and say, by combining some of these business processes and technology there can be greater synergy, greater efficiency and that's a proposal that we make to the clients, who then evaluate it and then hire the pilot. In other instances, the client themselves realize that there is an opportunity for leveraging the technology capability in a business process, come to us and we work on those areas.

It's-- there's a fair amount of work that we have to do during the initial stages in terms of identifying what these processes are, what are the key cost drivers, what are the efficiency drivers and then go forward. So it tends to be a little slow during the initial stages in terms of identifying the process and it's not a-- we are not talking about hundreds of people working on these processes because they're very, very specialized processes.

OK, fair enough. And then just maybe one more question, Lakshmi. You were talking about your SAP practice and some of the things that you're doing in upgrades in NetWeaver and 24/7 and the like. To the extent that you can figure it out, a lot of players are doing a lot in SAP now in India. What do you see there that might be differentiated versus some of our competitors?

The areas that we are trying to focus on in the enterprise business solutions-- as you know, our CRM on the PeopleSoft practice and Oracle practices now are among the strongest. SAP is the area where we are building credentials. We are building referenceable customers. The opportunity or the tack that we have taken here is to work on some of the specialized tasks of SAP like the Business Warehouse or the new NetWeaver platform, which we believe has the opportunity to be a strong integration platform in many of the SAP sites.

We are trying to build a capability in that leading edge area so that we can convert or move the large base of customers who are using earlier versions of SAP to the new versions. That's the area that we are investing, both in terms of tools, understanding the product and specific methodology that will be unique to our office.

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

Bryan Keane, Prudential.

I just want to clarify. Strategic clients were up 5, but I heard a total of 60 and I thought it was 53 the prior--?

Hold on one second. Bryan, my apologies. You're right. It was 53, so it should be 58.

58, OK.

I'm sorry. There was 2 that dropped off a couple years ago. My apologies on that.

OK. And what's the best way-- because I get the question a lot, how penetrated do you think those strategic clients are? Is there any way to quantify that or can you just give us some color or comfort around that?

At a macro level, we have a lot of opportunity left. Only 5 of the 58 strategic clients are what we view as mature, which means we think we have as much as we can get.

One of the interesting things that's happening, it's sort of resetting the penetration bar at a lower level for us, is clients are now looking to do a broader range of services offshore. So there are additional budgets that we can tap into such as testing, such as infrastructure management, such as BPO. And it takes several years, at a minimum, to fully penetrate an account. And so many of the strategic accounts we've only won over the last 24 months. It's tough to come up with an exact number, but it's still early days for penetration.

How many do multiple services like testing and BPO along with apps development and maintenance?

A few. Some of the tier-1 players are doing that.

You mean from a client standpoint?

Right.

From the clients, in terms of our cross-selling ability, I would say the percentage is something like anywhere between 30% and 40% of our-- 30% to 40% of our customers who use multiple services.

OK. And then just lastly, you talked about BPO and specifically the financial services as being an area of expansion. Is this something that we should start monitoring as a percentage of revenue? Or is this going to be one of the bigger avenues of growth going into '06 and beyond?

Not yet. Not yet. This-- in this business one should also realize, even if the headcount reaches some meaningful numbers, the revenue is unlikely to reach meaningful numbers until you establish a significant scale. So it's too early to put any numbers on that.

And, Bryan, the reason for that is the BPO stuff tends to be very, very heavily offshore, so the revenue per head is just a lot lower. Margins are good. It's-- from what we're seeing, it's going to be-- the stuff we're going after is going to be good business, but for it to have a meaningful revenue contribution, it's got to be a lot of heads.

Thank you all of-- thank you, all, for joining us on today's call. In closing I just wanted to make a few remarks.

We continue to see strong demand for our unique service offerings across a range of industries. Cognizant's investments in its people, infrastructure and the development of additional best-of-breed service offerings leave us confident that we will continue to be able to meet the current demand and anticipate and fulfill our clients' future needs.

Our pipeline of opportunities remains as strong as ever. We anticipate strong execution performance over the remainder of this year and I look forward to updating you on our continuing progress. Thank you very much.

Ladies and gentlemen, this concludes today's Cognizant Technology Solutions second quarter earnings conference call. You may now disconnect.