高知特 (CTSH) 2005 Q4 法說會逐字稿

Good morning. My name is Michelle, and I will be your conference operator 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 speaker's remarks there will be a question and answer session.

[OPERATOR INSTRUCTIONS]

I would now like to turn the call over to Peter Schmidt of Financial Dynamics.

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 not, please call our offices at 212-850-5600 and we will be sure that a copy is sent to you. 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 and good morning, everyone. Thank you for joining us for Cognizant's fourth quarter and full year 2005 earnings call.

As we anticipated, 2005 was another exciting year of industry leading growth for us, marked by the achievement of several key milestones for the company. I'd like to summarize first this quarter and 2005 full year performance, and then talk about the trends from which we expect to benefit in the year 2006. We finished the year with record fourth quarter results and our performance for the quarter and the full year exceeded expectations. Using our strong technology expertise, business knowledge, and an industry-aligned structure, we collaborated efficiently with our customers to make a difference to their businesses. I'm pleased to report that our relentless focus on our customers has enabled us to surpass the milestone of an annualized $1 billion in revenue run rate towards the end of the quarter, firmly placing Cognizant in the top tier of the offshore IT services industry. We also finished the year with a record number of new hires, demonstrating the depth and ability of the management team to manage rapid growth. These achievements underscored the company's consistent execution discipline and focus. Our ability to effectively manage our industry-leading growth, while solidifying Cognizant's position as a customer-focused technology partner, capable of delivering consistently strong performance across all of our key financial and operating metrics. We begin the year 2006 with a strong management team, well-trained work force, a great partnership with our strategic customers, and a strong pipeline of opportunities to deliver industry leading growth.

This morning I'll discuss major factors underpinning our fourth quarter and full year 2005 results, and share with you the key drivers and overall market trends that show every sign of continuing to have a positive impact on our performance. I'll also discuss our outlook for 2006 and some of the investments we've been steadily making to support our growth well into the future. Francisco D'Souza, our Chief Operating Officer, will give color on some of the operational highlights in the quarter, and talk about key activities in 2006, and then I'll turn the call over to Cognizant's CFO, Gordon Coburn, who will take you through our numbers in greater detail.

Three factors with primary catalysts of our record performance in the fourth quarter. First, we strengthened our leadership position in our fastest growing verticals. Secondly, we continued to expand our range of horizontal service offerings, driving significant growth by allowing us to effectively cross-sell new services to our clients and meet the rapidly growing demand for complex large-scale outsourcing solutions. And finally, during the quarter, we extended our strategic customer relationships, the existing ones, based on our track record of continuously delivering high levels of client satisfaction through our tightly integrated global onsite/offshore business model, and a corporate culture grounded in the belief that client satisfaction is paramount.

Turning to each of these drivers in more detail, I'm pleased to report that we experienced secure growth across our major verticals during the fourth quarter. Cognizant further strengthened its leadership position in its fastest growing verticals -- Financial Services, which includes insurance, and Healthcare and Life Sciences. We won four strategic clients, including two global financial services firms and one global healthcare provider. We also signed a major telecommunications firm as a strategic customer, sustaining the momentum that we have built in our telecom vertical over the last several quarters. Schmidt As previously discussed, we define the 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.

As you know, Cognizant was one of the first offshore services companies to align its business across industry-- across vertical industries. A strategy rooted in our belief that deep industry expertise and domain knowledge will enable us to deliver the most value for our clients over the long-term and capitalize on new growth opportunities as we further expand our service offerings.

Turning to horizontals, growth in our horizontal services also contributed to our strong performance in the fourth quarter as we cross-sold new services to our clients. We saw escalating demand for a broad range of horizontal solutions, particularly high performance web development initiatives, complex systems development engagements, testing, Q and testing, customer relationship management or CRM, data warehousing, and business intelligence. We also began work on significant web interface development projects for many companies in our new technology vertical, which includes software product companies and global firms with sizable online businesses. I'm pleased to report that Gartner recognized our CRM practice as the leader among the offshore based providers. In addition, we saw an increase in demand for legacy to web transformation initiatives, as a result of our partnership with Microsoft. In recent quarterly calls, we have also discussed our rapidly growing ERP practice, specifically our strong partnership with SAP. Franc will give you an update on SAP and other service offerings in a few minutes.

Turning to our financial results, I'd like to point out that our strong performance clearly reflects our ability to successfully build deep relationships with our clients. We recorded revenue in the fourth quarter of $256.9 million, $4.9 million about our guidance, on an increase of 49% from the fourth quarter of 2004. Earnings per diluted share in the fourth quarter, excluding the one-time $0.08 benefit of repatriating profits generated in India, were $0.31, compared to $0.28 in the third quarter of 2005, and $0.21 in the fourth quarter of 2004. GAAP EPS was $0.39 for the quarter. We also added a total of 25 new clients in the quarter.

Overall, for 2005, revenue increased to 8 -- increased by 51% to $885.8 million, about our guidance of at least $881 million. Operating margin was 19.9% in the quarter and 20.1% for the year, consistent with our target margin range of 19 to 20%. Our focus on and continued success in our vertical practice areas highlights a key growth engine for Cognizant in 2005. On a full year basis, Financial Services and healthcare grew 52% and 51% respectively. As of the end of 2005, Cognizant works with three of the top five healthcare companies in the U.S. and 7 of the world's top pharmaceutical companies, emerging as a leader with deep domain and technology expertise in these verticals. Cognizant also recorded substantial growth in its testing, data warehousing, and business intelligence horizontal areas, and assumed a leadership position with broad industry recognition. Cognizant also completed the largest ever legacy transformation through the web and by virtue of its work with leading online web business leaders, it is recognized as the leading provider of high-performance web based solutions.

As I said earlier, Cognizant had a record number of staff in 2005, finishing the year with a net addition of 9,000 employees, bringing our worldwide total employment to about 24,300. We have successfully executed our growth strategy in large part because of our ability to attract the best and the most energetic minds in the industry. These top recruits, ranging from recent college graduates to MBAs, senior level architects, program managers, and vertical practice leaders, are increasingly attracted to Cognizant for its forward-looking corporate culture and strong reputation for both customer and employee satisfaction. With the steady focus on our long-term strategy, we continue to hire aggressively in anticipation of the strong demand for our solutions. The integration, training and development of new hires into Cognizant's customer-focused culture is a testimony to the management team and our rigorous systems and processes.

Our success builds upon the quality of talent that Cognizant continues to attract at all levels of the organization. In 2005, we increased the breadth and depth of our management team, and assembled a highly selective team of experienced world-class managers with extraordinary vertical domain and technology expertise, as well as first-rate management capabilities that compliment the executive management team that we have had in place since the early days of the company. These hires are consistent with our strategy of adding senior level industry experts who possess deep knowledge of the business and technology challenges that our clients face, enabling us to further strengthen our client relationships. I'm happy to say that our tremendous growth has enhanced our progressive corporate culture and dedicated enrichment in employee and customer satisfaction. Cognizant's growth is managed by a diverse, but cohesive group of leaders, and this strong unified and stable management team has enabled us to grow consistently, while maintaining our very high levels of satisfaction among both customers and employees.

Before discussing some of the key trends that we see driving Cognizant's growth in 2006, I'd like to have Francisco give you an update on some of our horizontal service offerings, and our infrastructure expansion projects.

Thank you, Lakshmi, and good morning, everyone.

On our last call, we discussed in detail our strategic partnership with SAP and the relationship with SAP Labs, for whom we are performing testing and quality assessment analysis on the entire NetWeaver stack. We continue to see the benefits of our investments in SAP, as customers are increasingly turning to Cognizant to build custom solutions and frameworks tailored to their specific industries, and also to support their ERP initiatives, from planning through implementation, maintenance, and upgrade cycles. We continue to build on our momentum and package implementation in general, and SAP specifically. Our ERP horizontal grew approximately 100% in 2005, and we continue to invest in this service line.

We are also seeing growing momentum for our infrastructure management services, which we announced in 2004. This practice is an example of our ability to anticipate our clients' needs and develop complimentary solutions to our core offerings, in this case our software maintenance services. Our infrastructure services group monitors, manages, and enhances the performance of every element of a client's critical IT infrastructure backbone, including networks, servers, databases, and applications infrastructure. This new service is growing rapidly and recorded a growth of about 125% over year 2004.

It was a great honor for us to have recently been named Supplier of the Year 2005 by JP Morgan Chase. The Supplier of the Year Award recognizes excellence by suppliers globally who demonstrate superior performance in quality, integrity, innovation, and value. Cognizant was one of only 8 firms, and the only systems integrator, to receive this award in 2005, from thousands of suppliers that affect JP Morgan Chase's business on a daily basis. We are extremely pleased with our team's performance, and we look forward to the continuing growths in our relationship with JP Morgan Chase.

As Lakshmi mentioned earlier, we continue to invest in our infrastructure and training to meet future demand for Cognizant's services. In 2005, Cognizant Academy, our in-house training and development division, completed a record number of courses, clocking over 1 million training hours. The Academy has expanded its footprint in India and overseas and now offers E-learning as a standard for all our employees globally.

With that I'll turn the call back over to Lakshmi.

Thanks, Franc.

A touch up on the outlook for 2006. Looking forward, several indicators underscore our belief that 2006 will be another record year for Cognizant. First is our ability to be the provider of choice in markets like Financial Services, Healthcare and Life Sciences. Our investments in expanding our vertical industry expertise, and range of services, as well as the industry expertise we have gained from partnering with the top companies in these industries, will only enhance our competitive advantage in these segments and boost our ability to win more new business. As more and more customers embark on the next wave of web deployment, Cognizant is in a very strong position to collaborate with its customers and deliver high-performance solutions.

Secondly, we begin the year 2006 with a strong and committed management team that has been stable for the past several years and has effectively inducted a number of new managers at all levels. And thirdly, we begin the year with the bulk of the human capital required to execute in 2006, trained and already in place. We anticipate that the superior client satisfaction we have achieved in 2005 will stimulate further growth. Of our 67 strategic customers at the end of 2005, only five have reached maturity, which is evidence of the tremendous growth potential of these customer relationships. And our top customers continue to grow their relationship with us.

We also continue to invest in areas that we believe will drive significant growth opportunities for Cognizant over the long-term, including Europe and our vertically-oriented business process outsourcing service offering. We also made the decision early on to keep the utilization collectively low, in order to enable us to respond quickly to the changes necessary to keep our business growing. Our strong performance in 2005 has demonstrated the success of that strategy and we are more confident than ever that we are well positioned for the year 2006.

With that, I'll ask Gordon to walk you through the numbers in greater detail. Gordon?

Thank you, Lakshmi, and good morning to everyone.

I'd like to provide some additional information on the fourth quarter and then discuss our financial expectations for Q1 of this year, as well as for full year 2006. Revenue for the fourth quarter exceeded our prior guidance, due to continued application management ramp-up of clients won over the past few years, and more importantly, continued greater than anticipated strength in discretionary development spending. A trend that started for us in the second quarter of 2003. Revenue grew 9% sequentially and 49% year-over-year. Our core business remains vibrant and our pipeline is robust. For the quarter, application management and application development each represented 50% of revenue. Both services grew significantly in Q4. On a year-over-year basis application management grew 42% for the quarter and 44% for the year. Application development grew 55% for the quarter and 59% for the year. On a quarterly sequential basis, management grew 5% and development grew 13%, reflecting the surge in development spending we experienced during the quarter.

The largest driver of growth in 2005 was Financial Services, which includes our practices in insurance, banking, and transaction processing. It grew by more than $150 million and represented 50% of revenue. Healthcare grew over $59 million in 2005 and represented 20% of revenue. Retail and manufacturing and logistics grew by over $45 million, representing 17% of revenue for the year. The remaining 13% of our revenue for 2005 came primarily from other service-oriented industries. During the quarter,88% of our revenue came from clients in North America, and Europe was 11% of total revenue. The remaining 1% of revenue came from the Asian market.

We added 25 new customers during the fourth quarter. We closed the year with an active customer base of approximately 250. During the quarter we added four 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 approximately 23 clients during the quarter, almost all of which were very small clients. During 2005, we added a total of 19 strategic clients, bringing our total number of strategic clients who are currently active to 67.

Turning to costs, costs of revenues increased 44% for the quarter as compared to the fourth quarter of 2004. The increase is due to additional technical staff, both onsite and offshore required to support our revenue growth. We increased our technical staff by over 1800 people during the quarter and ended the quarter with approximately 22,700 technical staff. This is a net increase of approximately 8500 technical staff from December 2004.

Gross margin was 47.1% for the quarter, an increase of 150 basis points sequentially. Gross margin in Q4 was positively impacted by items such as the depreciation of the Indian Rupee throughout the fourth quarter, the seasonal hitting of cap for FICA in the U.S., the seasonal flattening of the pyramid due to the time of college graduate hires, and a slight shift in the mix of our work toward offshore, which has higher gross margins. SG&A expenses, including depreciation, was $69.9 million, up from 42.9 million in the fourth quarter of 2004. As a percentage of revenue, SG&A was 27.2% in the fourth quarter, up 240 basis points from the fourth quarter 2004, and up 160 basis points sequentially from the third quarter of 2005. During the quarter, we continued to strengthen our vertical and horizontal expertise, and we aggressively hired client partners to manage and grow our customer base, and we further enhanced our reward, training, and leadership programs for our employees.

Operating income for the quarter increased 45% to $51 million, from $35.3 million in the fourth quarter of 2004, and our operating margin was 19.9%, which was at the upper end of our target operating margin range. Interest income for the fourth quarter increased to $2.9 million compared to $1.5 million in the fourth quarter of '04. Interest income increased due to our higher global cash balance as well as increased U.S. short term interest rates. We had a $737,000 foreign exchange loss during the quarter, due to the India Rupee and European currencies. This was all balance sheet exposure.

Excluding the beneficial impact of our year end repatriation, which I will discuss shortly, our tax rate for the year was 17%, slightly below our prior estimate of 17.8%. The decline resulted from the location of our profits, differing slightly from our expectations when we gave our prior guidance. As previously disclosed in the fourth quarter of 2005, Cognizant completed repatriation of approximately $60 million of earnings, pursuant to the American Jobs Creation Act of 2004, leading to a one-time income tax benefit of $12.4 million or $0.08 per diluted share. Our GAAP tax rate for the year was 10.3%. This includes the one-time $12.4 million beneficial tax impact of our year end repatriation to which I just referred.

Turning to the balance sheet, our balance sheet remained very healthy. We finished the fourth quarter with approximately $424 million of cash and short-term investments, up over $55 million from September 30th of 2005. During the fourth quarter, operating activities generated approximately $68 million of cash. Financing activities, primarily the exercise of stock options, generated an additional $13 million of cash. These amounts were partially offset by approximately $24 million in capital expenditures during the quarter, including expenditures on our India construction program. In addition, we used $2 million of cash due to currency translation adjustments. For the full year, our cash and short-term investments grew by approximately $109 million.

Our collection of trade receivables during the fourth quarter improved from September levels. Based on our $176 million plus balance on December 31st, we finished the quarter with a DSO, including unbilled receivables, of 63 days, compared to 67 days at the end of September. Excluding unbilled receivables, our DSO was 55 days. The quality of our receivables portfolio remains very strong. Our unbilled receivables balance is $22.7 million at the end of the fourth quarter, down $2 million from the September levels. The decrease in unbilled receivables resulted primarily from the timing of fixed bid milestones at year end. On a year-over-year basis, unbilled receivables increased approximately $8.6 million, primarily due to overall volume growth of the business.

During the fourth quarter overall 25.7% of our revenue came from fixed-bid contracts, a 150 basis point increase from the third quarter of 2005 and up from 24.6% in the fourth quarter of 2004. When we look at the mix by solution type during the quarter, 33% of our development revenue and 19% of our maintenance revenue came from fixed bid contracts. On a full year basis, overall 25.2% of our revenue came from fixed bid contracts.

Turning to headcount, at the end of the fourth quarter, our worldwide headcount including both technical professionals and support staff totaled just over 24,300. This represents a net increase of over 1900 people during the quarter and over 9,000 people compared to December of last year. Approximately 50% of our Q4 hires were recent college graduates who will enter our training program and the remainder were lateral hires of experienced IT professionals. Based on our 2006 revenue expectations and ongoing success in recruiting, we currently expect to exceed 34,500 people globally by the end of 2006, and we are moving along well toward this goal, having hired over 1,000 employees last month alone. Turnover, including both voluntary and involuntary, was approximately 14% annualized during the fourth quarter. For the full year, our total attrition was approximately 15%. The vast majority of Cognizant's turnover occurs in India, resulting in onsite annualized attrition rates below the global rate. In addition, attrition is heavily weighted toward the most junior members of our staff.

Onsite utilization was around 85% for the quarter. Offshore utilization, excluding recent college graduates who are in our training programs during the quarter, was approximately 69%. Including trainees, offshore utilization was approximately 52% for the quarter. We had approximately 3,500 unbilled people in our training programs at the end of the quarter.

I would now like to comment on our growth expectations for Q1, as well as full year 2006. As we mentioned on our third quarter call in October, we have been receiving positive feedback from our clients and account managers about account growth opportunities in 2006, as clients seek to do a broader range of services with us. We are projecting revenue for the first quarter of 2006 of at least $275 million. We continue to have significant revenue visibility due to our high level recurring revenue and the long-term nature of our customer relationships. In fact, today we have customer commitments for well over 90% of our first quarter revenue guidance. For the full year 2006, based on the strong demand environment for offshore services and our favorable ramp-up experience rates we project revenue to be at least $1.26 billion. This represents growth of at least 42%.

As has been typical in prior quarters, we expect the majority of our growth for Q1 and full year 2006 to come from the ramp-up of clients won over the past few years. During 2006 we intend to continue to closely monitor our spending and expect our operating margin to remain in the 19 to 20% level, in line with our historic margin level and prior guidance. As stated on previous occasions, please note that our operating margin target and guidance excludes the impact of FAS 123R equity compensation expense. With this expected level of revenue growth and expected operating margins, we are currently comfortable with our ability to deliver in Q1 GAAP EPS of $0.29, an EPS of $0.32 excluding FAS 123R equity compensation expense. This guidance includes the anticipation of a Q1share count of approximately 149 million shares, a tax rate of approximately 17.5%. Operating margin in the upper half of our guidance range, once again excluding the cost of FAS 123, and the absence of further nonoperating foreign exchange gains or losses. Based on current business trends we expect GAAP EPS for the full year of at least $1.30, and full year EPS of at least $1.43, excluding FAS 123R equity compensation expense. This guidance includes the anticipation a full year share count of approximately 150 million shares. In addition the guidance assumes the full year tax rate is 17.5%, operating margins in the upper end of our guidance range, excluding FAS 123 and the absence of foreign exchange gains or losses. We expect the vast majority of our Q1 full year growth to come from existing clients, particularly the numerous strategic deals we have won in the past few years. As we look ahead to all of 2006, we are highly encouraged about our prospects for continued industry leading growth.

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

[OPERATOR INSTRUCTIONS]

Your first question comes from Julio Quinteros with Goldman Sachs.

Gordon, good morning, Lakshmi-- good evening, I think-- or good morning, depending on where you are located today.

Lakshmi's sitting right here in Teaneck with us.

Oh, ok, well, good morning to both of you guys.

Real quick on the utilization trends as we go forward, given the pace of timing that you guys are obviously doing, what should we expect for utilization trends as we look forward in 2006? Which quarters could be lower than expected utilization trends because you're ramping up, and just kind of remind us what the normal quarterly trends will look like, especially as it relates to the normal hiring calendar that you guys go through in the course of the year.

Sure thing. You need to break that into onsite and offshore. Onsite we stay in that mid to upper 80% range. Offshore, you have to look at utilization with and without trainees. If you recall in early 2004, we changed our business model. We used to try to hire all the trainees in the summer. Now we try to hire them more evenly throughout the year, so you don't see the same spikes and troughs in terms of utilization including the trainees. So you'll continue to see a spread between with or without trainees. That will change it a little bit. December sort of tends to be the peak period because you do still have more trainees coming in the back half of the year than the front, but if you look at '05, you saw the gap closed a little bit in Q1 and Q2 and then opened up, so I'm not sure you would expect any dramatic swings in utilization.

Okay. Thanks. And then, related to the onsite offshore again --

I'm sorry, let me add one more comment to that. And one of the things where I think we've been very successful is actually running the business with a utilization level that allows us to quickly respond to our clients. As clients are looking to do a broader range of services, we don't know if the next contract is going to be for 200 testing people or 200 .Net people, or 200 infrastructure people, so we want to make sure we have a very deep and broad bench so we can respond quickly and effectively to our client needs.

All right. Sounds like some other guys are also looking at your same playbook in that regards.

Yes, I think people have looked at what we're doing and realized, that's the successful magic.

Yep. Appreciate that. Just really quickly on the onsite offshore effort mix, did you actually provide that number or can you provide it if you didn't?

Yes, I'll give it to you. For the quarter, we moved about 1% more offshore, and I'm just going to get you that statistic. We are 25% onsite, 75% offshore, and that was about a 1 percentage point movement from prior quarter, and that always bounces around a little bit.

Okay. And then, did you provide the account data for the quarter? Five, top ten et cetera?

Sure. Top five was 34% of revenue. Top ten was 45% of revenue.

I'm sorry. 34 and 45?

That's correct.

Okay. And then in the top account, is there just one account that's over 10%?

Actually for the full year there were no accounts above 10%. Our largest account, as Francisco mentioned earlier, continues to grow but obviously at a slower pace from the overall business. So on a full year basis, there were no accounts above 10%.

Okay.

Let me just be really clear there. Our top accounts, we do not view as mature. We continue to see what we believe are very healthy growth opportunities.

But as of last quarter, though, you still had one account that was over 10%?

Actually in Q3 we had two accounts that were over 10%. Now obviously they weren't a lot over 10%, but because of the strong growth we had in Q4, that put them just below 10%.

Got it. Okay. Great, thanks.

Your next question comes from Adam Frisch with UBS.

Thanks and good morning.

Just to expand on that point a little bit, on the offshore company, there seems to be a trend that offshore companies are stretching to keep even a bigger bench in India than they have historically. It's never been expensive, but why now are vendors suddenly making a bigger push to expand the bench even more? Is it because of the demand, or because skill sets are more specific and not flexible between different kinds of projects, or what?

Yes, Adam, the way we look at it is, the utilization is correlated with the growth. The faster the growth, the lower the utilization in order to keep a bench of people. So, we have to keep the people hired and trained, because there is a broad set of services that we are expected to deliver. So it's the-- as the breadth of service offerings increase, we need to keep a certain minium number of people trained in each of those service offerings, that automatically contribute to our higher bench strength, and slightly lower utilization. And this is something that we continue to monitor, so the way to look at it is, growth and utilization are very closely correlated, and the utilization will be lower at the solution set that we offer, broadened over a period of time.

Okay. Switching gears, on utilization, Gordon, you said for the year we should expect it to be pretty similar for '05, including training?

You talking about for '06?

Sorry. Yeah for '06.

We don't guide to utilization, but yes, as I mentioned earlier, I don't see anything structurally in the business that says it's going to change materially. Obviously, I'm sorry it won't stay exactly where it is, but there's nothing structurally that changes it.

And any pricing expectations for '06 for offshore resources?

Let's not focus on offshore benches over all pricing, which is really what matters. Our assumption is it will be up a little bit again in '06, just like it was in '05 and '04. We don't expect it to be up dramatically, but in '04 and '05 I think each year was up about 1.5% on average. That's probably a reasonable assumption for '06.

Okay. And then, finally, you're a much bigger company today than you were even a few years ago. With the growth, are you still small enough where you're looking at your upper bounds of growth in percentage terms, or now that you're bigger, are you looking at it more in terms of absolute numbers or dollars?

I think it still becomes a little bit of both, Adam. I still think about it in percentage terms, because you remember the constraint to growth is not recruiting, it's not training but it's integration of people onto existing project teams, and as that denominator gets bigger, of having more project teams, obviously you can integrate more people, but I think over time the percentage does come down a little bit, but it's still -- it's still as a percentage of the base, but probably the percentage slowly comes down.

So that range that you have been quoted on repeatedly, anywhere from 30 to 60, that's still kind of the range that we're looking at? I don't care-- I don't expect you to comment on the exact number or anything, but something around 45, 50% is not out of reach based on where your size is today. Right?

If the demand were there, and that's an if. Obviously we guided to at least 42%. If the demand were there, I think it's reasonable that we would have to supply to deliver that demand.

And the infrastructure to handle it?

Yeah, the constraint -- if there were ever a constraint, it wouldn't be infrastructure, it would be just integrating people on to project teams at-- and the levels you're talking about, I would not see that constraint if the demand were there.

Okay. Cool. Thank you, guys.

Your next question comes from Ashwin Shirvaikar, with Citigroup.

Hi. Nice quarter, guys. Congratulations.

As we look across your strategic clients, what does your penetration of wallet share on those clients? I have to think it's probably really small, maybe a couple of percentage, is that right?

It's still small. I think I've used this statistic, if I look at my existing customer base, we're probably only 20 to 30% penetrated in terms of what we believe they want to do with us. And obviously with some of our older clients, we're more than 20 or 30%, but we want to log strategic deals recently where we're very low single-digit in terms of penetration, so we have a lot of opportunity just in our existing customer base, and that's why I mentioned that we expect the vast majority in our growth in 2006 to come from customers who are with us today. And I think that will always be the case because remember, when we win a new customer it takes three to six months before you really hit the inflection point on growth, and obviously because we have won so many strategic accounts over the last couple years, we're in that type of growth phase for a large number of them. And because we're running at a lower operating margin than many others in the industry, we've been very successful at actually growing these relationships because we can invest in the client partners, the industry expertise, all the things that help grow relationships quickly.

Okay, and not to put you guys on the spot, but as you consistently grow an order of magnitude faster than the industry and faster than budget growth, who's getting squeezed out? Who are you replacing, in effect?

The way to look at it is-- if you look at it from the demand perspective, the demand is very strong. Are we anywhere near servicing all the demand that exists in the market? No. The way to address the demand is, what have you got in order to deliver the two key components are, do you have a good solid management team, and do you have the people to deliver results? So if you continuously invest in the management team, both in terms the expertise and the depth and breadth, as well as sufficient number of people that are trained and available, you can meet the demand. So it's typically these three components and demand is a given. The supply side you manage is a good management team. And manage the utilization of resources that are trained and available at all points in time.

Okay, and if I may ask a couple of housekeeping-type questions. Gordon, what's your currency assumption in '05-06?

The the budget assumption is that it stays right around where it is now.

Okay, and any changes with the timing of rate increases?

Similar to the majority of the industry, we would plan on our general wage increases happening in April, same last year.

Okay. And as I look at your rather substantial cash balance now. Is it make sense to think of it as a whole, or should I think of it as two buckets, one in India, one in the U.S.?

Think about it as one bucket.

One bucket. Okay, thank you. Great quarter.

Thanks, Ashwin.

Your next question comes from Moshe Katri with SG Cowen.

Hi, good morning and let me add my congratulations for a very strong quarter.

Cognizant is clearly firing on all cylinders, especially relatively to some of your competitors. It also seems that Q1 guidance, at least directionally, is much more upbeat than the typical patterns, at least based on the historical patterns. Can you comment on both of these data points? And then, can you also repeat your target for headcount for '06? Thanks.

Let me start with the target for headcount for '06. At least 34,500 people, and that basically ties into the same level of growth as the revenue growth. You know, Q1 last year we were a little bit -- it was not a particularly strong quarter. January did not get off to a great start, just because of the timing of clients' budgets and so forth. This year we guided to about 7% sequential growth, 51% year-over-year growth, and that's really based on-- clients are just getting more comfortable with us. We've hired a lot of these client partners and relationship managers and that's making a huge difference in further improving this, where the planning cycle with the clients, so we don't have as much of that January lull during the switchover of the budget cycle. So I think it's an investment we're making, and SG&A is making the difference.

Okay. Can you also comment on maybe just generally your performance versus some of your competitors? Do you think just because, on a relative basis, you do have a different focus, maybe a different verticals that you're focusing on, maybe just the way you've been investing in your infrastructure throughout-- during the past few years or so?

Moshe, let me answer that question. The key differentiator is the investment that we have made in the front end of the organization, the people, the specialists who work with our customers day in and day out. That's showing up as a difference, we are able to tackle some of the higher-order problems that some of our customers are facing and implement solutions very, very effectively. Thereby earning the right to continue the relationship, continue to grow the relationship, as well as getting higher levels of customer satisfaction. So it's primarily the investment in the front end of the organization, and the corporate culture of an empowered organization, that clearly differentiates us from the rest of the people. While the others are perceived by the market as technology companies, we have seen as a company that focuses on making a difference to their clients' business and focuses on the outcome to the client's business.

So-- and then looking at Q1 again, beyond just the-- you're saying you've made some investments in relationship managers and you feel that the whole process is a bit more effective here. Is there any change fundamental in demand? Is this just a function of your maybe operating a bit more efficiently here, or this would be a thing that demand is just accelerating in your case?

As Gordon pointed out, the proportion of the revenue of the development side is increasing, which means customers are investing in new initiatives and transformation work and supporting new revenue streams, that requires a higher audit capability, both in terms of domain and technology. So given that, that's a big push for us. We are almost even between maintenance and development work, and so we continue to see an increasing trend in development, particularly as more and more of these new solutions are deployed on to the web and there is a new wave of development that's happening on the web, there we are very well positioned, thanks to some of the relationship that we have with the customers who are have a significant percent on the net.

And if the development portion is accelerating as you're saying, would it be correct to make an argument that, on a relative basis, the revenue conversion is much quicker and at least the visibility improves as well? At least on your term?

Yes, one can say that. But, let's say two years back, would have been extremely conservative about the proportion of the development revenue in terms of forecasting. Now we are a little more comfortable as to the trends.

Thanks. Great. Good quarter.

Your next question comes from Andrew Steinerman with Bear Stearns.

Good morning.

Gordon, could you just go over pricing and just give us more precise numbers in the quarter? I know you gave a direction for the whole year and next year, and also in the sense of pricing, I know it's pretty much coming up, as you said, 1.5% as it happened in the past. But don't you think that Cognizant and other offshore services firms could exhibit a little more pricing power than that? We had a recent conference call with many large users that emphasized quality over price, already getting quite a good price. Don't you think that Cognizant and you peers could get a little more out of price?

Andrew, let me answer your specific question on rates and then I'll have Lakshmi give his views on pricing power and the tradeoffs on that.

Thank you.

For the quarter sequentially, pricing was essentially flat. Now obviously there are lots of gives and takes. Obviously as our BPO business is starting to gain a little traction, up to that is lower rates, the high-end development at higher rates, but now they're all out as essentially flat, sequentially for the quarter. Year-over-year, we were up 1 or 2%, probably about 1.5% or so, exactly where we expected to be. And as I mentioned, probably about 1.5% on average next year and obviously there are lots of gives and takes in there.

And that was offshore, $25 an hour or are we talking about combined?

I'm talking about both onsite and offshore, we're pretty much flat with last quarter.

So pretty much 25, 71, unchanged.

Yes, 24.5 and 71, right around there.

Okay. Thank you.

And, Lakshmi, do you want to comment on, just pricing power?

Yes, at this point in time, all I'd like to say is we don't face that much of a pressure on the pricing normally at any point in time. While there is an upward trend but usually there is some pricing pressure on large contracts, on multi-year opportunity [inaudible], but we don't see that kind of a pressure. It doesn't automatically mean that there is a scope for a-- improving the prices, but I will view that lack of pressure favorably, for that longer term. If the present day employment rate continues et cetera, we could have some advantage in terms of picking up our prices.

Super, thanks for the comments.

Your next question comes from Bryan Keane with Prudential.

Hi, good morning.

On my count, the strategic clients were up above 19, which obviously is a big number. Can you talk about how that pipeline looks in the sales cycle by region, I guess, specifically U.S., Europe and Asia?

Let me have Francisco answer that, he's clearly the closest to it.

Sure, Bryan, I think we continue to see strong demand for service for across the industry that we serve in the U.S. Let me take the geography question first. In the U.S., we continue to see strong demand across all of the industry verticals that we served and as we said on prior calls, one of the phenomenon we saw in 2005 was new industries that historically had not been aggressive adopters of offshoring coming online and starting to use offshoring as a core part of their business and IT strategy. In Europe, we continue to see healthy traction in the UK market, and we're growing nicely there. And we're starting to see a pick up of interest across continental Europe. That's still relatively early, but the signs of demand picking up in continental Europe are certainly there. That will continue to be an area of heavy investment for us in 2006 so that we can see that as a growth opportunity for the long-term. In terms of the pipeline for-- of strategic clients, I think it's very much mirrors that same approach. We're seeing, you know, good pipeline of strategic clients here in the U.S., and some in the UK, and then beginning to see signs of that in continental Europe as well.

And then, how long does the decision process usually take? Is it a six-month sales cycle and then secondly, when you do sign a strategic client, is usually the term of the deal a year, one year, what's the length?

Sure. The -- I think that the-- a good rule of thumb is about a six month sales cycle, although every client is different and you have situations that go longer than that and situations that go sometimes more quickly than that, but a good rule of thumb is six months, and generally speaking, the way these strategic clients work, Bryan, is that these are really, if you will, we'll use the term hunting license before. We win a client, they select us, sometimes exclusively, sometimes with one or two others suppliers as their preferred suppliers, but then you really have to go through the organization and essentially win projects on a case by case basis and so the contracts are often-- are generally long-term beyond a year. Sometimes they're evergreen, but there's no guarantee of work. You have to go through and win projects on a case by case basis and that's why after we win a strategic client, there's often a period where you are working with the client organization to identify pieces of work. So before you hit the inflection point in real growth it could be many months before -- after, excuse me, you've won the strategic client.

Okay, and then just finally Gordon,, the 20 to 30% penetrated that you mentioned with strategic clients, that's of their planned spend, so basically they have a larger table that it looks like that you can incorporate in your future revenue guidance that's not even near that 100% level.

Yeah, it's very importantly to note, Bryan, that's their planned spend with us. Obviously some get to that number, some go way beyond that number, some never get anywhere close to it, but generally when we win a deal, clients say hey, if it all goes well here's where I want to get to with you. So it's based on that, it's not based on anything contractual, and it's a scatter ground. It's somehow gone way beyond that number. Others are still sitting at small numbers.

Okay. And then let me just ask one last followup. Do you feel like you're taking business away from other tier ones that also have the same clients, or is that tough to call?

You know, it's mostly the-- it's not taking substantial work from others, but that it's primarily from their in-house department, that's the way it has been. I would say it's new work that's coming out that's outsourcing.

Okay, thanks a lot.

Your next question comes from Cynthia Houlton with RBC Capital Markets.

Hi, congratulations on the quarter.

Just a couple questions, first on-- just an update on EDS, you didn't mention that in terms of any progress you're making the in terms of working with them, and any projects that you're working on jointly?

Cynthia, let me have Francisco answer that. He works -- he's very close to the EDS relationship.

Cynthia, we're about six months into our relationship with EDS and as we said, when we first announced it, the relationship with EDS, we view EDS very much like we view our other strategic clients. We signed the agreement with them, as I said, about six months ago and we've been working over the last six months with them to identify specific opportunities that-- on numerous fronts with them. I'm pleased to say that we're now starting to see that starting to ramp up. We are working with them across a few different opportunities and we're very pleased with the progress that we've seen over the last six months.

Great. And then, just, when you look at your pipeline and the types of people you're looking for, could you give us a sense of both your current offshore mix and then what you see the future of, in terms of the skill level needing due? 90% need EEs, and kind of what the mix of people you're looking for in your offshore locations, given new services like BPO and infrastructure services?

Yes, it's broadly-- we continue to focus on the technology people, people with engineering qualifications for our-- primarily with computing, and one of our key differentiators is the number of MBA and [inaudible] graduates that we hire. We continue to hire a large number of those and integrate them with the technologists to provide business-oriented solutions. But typically this is-- the profile is, technolgists, not the MBAs, who constitute the bulk of the work for us, and they are trained and developing with the organization and project management capability and domain capability in order to service the customers.

Okay. And then just a final followup is on the M&A environment, Gordon. You know, is that more active, less active in terms of looking for a niche strategic fits?

Cynthia, as you know, we're very selective in what we do. But there is-- there are interesting opportunities out there, we focused on three areas and continue to focus on three areas. One is geographic expansion, we've done acquisitions there, two is specific technology capability, and we've done acquisitions there, and third is industry-specific capabilities, so we continue to look for all three, and as we can find interesting things, we'll certainly act on it, but you know, we-- because we have such a healthy organic growth outlook, we have the luxury of being selective, but I would certainly expect and hope that we'll be able to find things in the future just as we have in the past.

Great. Thank you.

Your next question --

Operator we have time for one more call.

Okay, your final question comes from Rod Bourgeois with Bernstein.

Yeah, Gordon, it's Rod here.

I wanted to see, in your guidance for 2006, can you give us any sense for how much revenues you're assuming from the relationship with EDS?

The -- Rod, as you probably know, our philosophy is never to break out to specific customers and that's due to client confidentiality. It's not our place -- if a client wants to talk about what they applied to with us, we leave it to them. As Francisco mentioned, we view EDS as a strategic customer. We're about six months into it and we're very pleased with the way the relationship's going.

Okay.

Similar to, we're pleased with the way a lot of other strategic accounts are going. So, we think it will be a -- it's a good -- it's a very good relationship and we think there's good opportunities there.

Alright, without disclosing what the level of revenues is, can you give us any sense, if EDS were to complete an acquisition in the offshore market, would you expect that your relationship with EDS would change at all?

The-- as Francisco mentioned-- may have mentioned, you know, EDS -- when we announced this relationship, you know, it was-- we are not the exclusive offshore provider and there was not expectation that we would be the exclusive offshore provider so we -- I -- there are rumors every day in India. I have no idea what rumors are true, what are not. But, what I can-- what I can focus on is. if we have a healthy relationship and a growing relationship with them.

Okay, that's great, and one final thing. There's a trend toward the Indian firms winning larger contracts. Do you assume in your guidance that you'll begin to win more of the larger deals that are out there?

It's kind of funny, the-- we have been winning larger deals. I think the difference is there are two types of deals. There's where it's an upfront committment, and where it's a hunting license. We tend to focus on the hunting license deals. Now, those deals can end up being as large or larger than the ones where it's an upfront committment, but obviously they're not as visible upfront, so we're feeling very good about the portfolio of customers that we've won, the strategic customers, and that some of them can become quite large.

Well, that hunting license approach is certainly working and paying off, so sounds like the right strategy. Thanks very much.

I'd now like to turn the conference back over to management for closing remarks.

Thank you. Thank you, Gordon for those comments and in conclusion, I'd like to state that our performance for the fourth quarter capped a tremendous year for Cognizant in 2005. Our success in recruiting the best talent in the industry, and the focus in expanding our service offerings is capturing new revenue opportunities and dedication to building deep relationships with our customers, rooted in our commitment to delivering the highest levels of services in the industry and enables Cognizant sustain exceptional growth in 2005. More importantly, we believe that we have put in place the right foundation to continue our industry-leading financial and operating performance in 2006 and beyond.

Thank you for joining us on the call today and we look forward to speaking to you the next quarter.

Thank you, ladies and gentlemen. This concludes today's Cognizant Technology Solutions fourth quarter earnings conference call. You may now disconnect.