高知特 (CTSH) 2006 Q1 法說會逐字稿

Good morning. My name is Cynthia and I will be your conference operator today. At this time I would like to welcome everyone to the Cognizant Technology Solutions first quarter 2006 earnings conference call. [OPERATOR INSTRUCTIONS]

I would now like the turn today's call over to Julie Huang with Financial Dynamics for opening remarks.

Thank you, operator, and good morning, everyone. By now you should have received a copy of the Company's first quarter 2006 earnings release. If you have not please call our offices at 212-850-5600 and we'ill be sure to get a copy sent to you. On the call we have Lakshmi Narayanan, President and CEO, Franciso D'Souza, COO, and Gordan Coburn, CFO of Cognizant Technology Solutions. Before we begin, I'd like to remind you some of the comments made on today's call and some of the responses to your questions may contain certain forward-looking statements. These statements are subject to the risk and is uncertainties as described in the Company's earnings release and other filings with the SEC.

I would now like the turn the call over to Lakshmi. Lakshmi, please go ahead.

Thank you, Julie and good morning everyone. Thank you for joining us for Cognizant's first quarter 2006 earnings call. This morning I will provide an overview of the highlights of our first quarter and discuss the key drivers of our financial performance. I will also discuss investments that we made in Tahiti making in the business to ensure that we continue to effectively manage our industry-leading growth while producing consistently stronger sales across our key financial and operating metrics. I will be joined on today's call by our Chief Operating Officer, Francisco D'Souza, who will give color on some of the operations highlights in the quarter and investments we are making in our infrastructure. And our CFO, Gordon Coburn, will take you through our numbers in greater detail.

We're extremely pleased with the performance of our business in the first quarter. While our overall numbers were outstanding, what's more significant is how we achieved these results. Continued strong performance of our largest verticals was augmented by strong growth in our newer verticals, where we have been making significant investments. This performance was also enhanced by the investments we have made in our client relationships, delivery organization, new services and the development of our growing management team, which contributed to continued delivery excellence. As we said on our last conference call, we began the year with all of the required resources firmly in place to sustain our momentum in 2006, and our outstanding first quarter results are a testament to the consistent execution of our strategy. Furthermore, our firm's continued to out pace the market and strengthen our confidence in our ability to deliver another exciting year of growth for Cognizant.

Turning to our first quarter results, we exceeded our internal expectations and guidance to investors, generating $285.5 million in revenue, which was $10.5 million above our guidance and represented an increase of 57% from the first quarter of 2005. GAAP EPS was $0.32 for the quarter. Non-GAAP EPS which excludes stock based compensation expense in the first quarter was $0.36 compared to $0.22 in the first quarter of last year. We also added a total of 32 new clients in the quarter, five of which are considered strategic and have the potential to generate between $5 million and $40 million or more in annual revenue for Cognizant over the long-term. Because revenue was ahead of our expectations this quarter, our GAAP operating margin was 18.6% and our non-GAAP operating margin was a robust 21.3%, above our long-term non-GAAP target range of 19% to 20%. We intend to use this out-performance to accelerate investments over the next several quarters to remain consistent with our longstanding development strategy.

Three primary factors were the drivers behind our success in the first quarter. First, we delivered strong growth across a broader range of our vertical practice areas, especially in our newer verticals including telecom, media and entertainment and new technology verticals. Secondly, we saw strong demand for strategic applications development initiatives, as well as increased discretionary spending, which further enabled us to successfully leverage our expanding set of integrated services to further the unique needs of our growing customer base. And lastly, we continue to deliver high levels of client satisfaction through our inherent customer-centric focus, which enabled us to significantly expand existing customer relationships during the quarter and secure new client wins.

Focusing on each of these drivers in more detail, we further strengthened our leadership position in our fastest growing verticals with an exceptionally strong performance in healthcare and life sciences, which fostered a 16% growth from the fourth quarter and 77% growth from the first quarter of 2005. This growth was led by our life sciences practice, as we continue to deepen our relationships with seven of the world's largest pharmaceutical companies. We're also particularly pleased with the strong results in some of our more recently developed verticals, such as media, new technology and telecommunications, all of which have generated substantial sequential and year-over-year growth, [another sign] of our investments in senior level expertise and expansion of our service offerings over the past year.

Media, which is an industry awakening to the offshore trend, roughly doubled from the year-ago quarter. Our new technology verticals, which consists of software product companies and global firms with sizable on-line businesses, continued to build momentum from its strong run at the end of 2005, posting approximately 30% sequential growth through our work on significant web 2.4, another development initiative. Telecom also gained traction during the quarter as a result of the resources added from our integration of Fathom which, as you know, we acquired in the second quarter of last year. The success of our vertical strategy is also evident in the range of our strategic client wins during the quarter. We won five new strategic clients spread across financial services, healthcare, manufacturing, media and new technology.

The second driver of our first quarter performance was our ability to successfully leverage our expanding portfolio of integrated services. Our strategy is to provide our customers with a complimentary suit of services that allows us to strengthen their businesses, from business analysis and strategy evaluation to applications development and implementation. Our success with this strategy was evident in our first quarter results as we experienced escalating demand for strategic development work, both new and-- from both new and existing clients capturing both discretionary IT spending and planned technology upgrade cycles. For example, for one of the large healthcare companies, we have a large team working in an integrated set of services that include application development, a platform development and maintenance initiator, as well as delivery of BPO services, using the platform. And for another large financial services customer, we have an engagement to transform the technology platform to deliver their services in an interactive manner to their customers. This is an engagement where our business and technology consulting group and the application development groups are collaborating in an integrated seamless manner.

We posted healthy double-digit sequential growth across our portfolio of services including ERP, CRM, testing, data warehousing and our advanced solutions group. As we said on our last conference call, we have continued to aggressively invest in our ERP practice, particularly around SAP. This quarter we announced the opening of our SAP NetWeaver® Test Center in our Bangalore facility as a result of our strong partnership with SAP and demonstrated in success and implementation including technology migrations, upgrades and custom development we secured several new client wins during the quarter of increasing scale and complexity. For example, we announced that Dow Corning had chosen Cognizant to optimize its supply chain network through strategic ERP and CRM initiatives. Ultimately, our integrated set of service offerings allows us to maximize the value we can add to our client's business and also generates opportunities to cross-sell our services and expand our client relationships, both of which contribute to the ongoing success of the Company.

This brings us to the third catalyst behind our strong performance, our steadfast commitment to client service, driven by our longstanding strategy of reinvestment in client facing capabilities. During the first quarter, we continued to deliver high levels of client satisfaction, which is supported by our recently completed annual customer satisfaction survey. Our clients commended us for our overall dedication to quality service, as our satisfaction scores remained at their historically high rates. In particular, our clients noted the efficiency of our delivery model, the caliber of our technical expertise and deep understanding of their businesses and, ultimately, our ability to apply our expertise. in order to drive significant value.

To take us through the details of our customer survey, I will now turn the call over to Franc, who will also give color on some of the operational highlights in the quarter, including investments we are making in our infrastructure to manage future growth. Franc?

Thanks, Lakshmi and good morning, everyone. Let me start with the customer satisfaction survey that Lakshmi referred to. Through this survey we received many comments from our clients that truly capture the Cognizant customer experience. Some of these comments focused on our ability to scale to the needs of our clients, with one client stating, "if you need to ramp up a large project, Cognizant is the one to go to. They have a phenomenal business model," And many highlighted our unique culture as key to our partnership and growth with them. These clients appreciate our approach of flexibility and do whatever it takes attitude and our transparency and openness. For example, one client stated "They are constantly jumping through hoops and making adjustments. They are willing to do that. We know we would not necessarily get that from another vendor." While another client shared, "A willingness to be transparent and open and let us interact directly was very important."

All of this adds up to the Cognizant customer experience, and with our high customer satisfaction scores and growth within our strategic clients, this approach has been key to our strong results. We use the feedback gained from the survey to enhance the quality and consistency of service that we provide to our customers, as well as to identify any new areas of investment that would enhance our ability to effectively serve them. Ultimately, the survey confirmed the high level of customer satisfaction that has allowed us to deepen many of the strategic clients brought on board over the last several years and unlock the tremendous growth potential across our client base.

I'd like to now briefly focus on three operational highlights to illustrate how we are managing our exceptional performance across the Company: Our success in recruiting; our talent, management and development; and our geographic expansion. With recruiting, as Lakshmi mentioned earlier, we continue to invest strategically in building our team, in order to have the capacity and resources to meet the rapidly growing demand for Cognizant's services. In the first quarter, we increased our head count by 10% sequentially, adding a net of 2,400 employees, which brings our global head count to 26,750. Through our highly selective campus program, we constantly comb the top universities and graduate schools around the globe to further expand our broad foundation of talent from recent college graduates to MBA's. As an example, during the first quarter, we hired approximately 200 business school graduates, nearly 10% of our net additions in the quarter.

In addition to recruiting from campuses, we also recruit experienced talent from the market place. We do this selectively, in order to compliment our existing teams around the globe with industry, geographic or specific technical or management skills. It is interesting to note that over one-third of our experienced hiring comes from referrals from existing Cognizant employees, a testament to the fact that our employees consider Cognizant a great place to work and are willing to recommend their friends and past colleagues to us. Through our recruiting program we strengthen our leadership team, adding seasoned professionals including senior level architects, program management -- excuse me, program managers, and key client partners in all our industry practices. In addition, we have significantly added to our European management team. I am also happy to report that all of our efforts relating to our people resulted in turnover, including both voluntary and involuntary, of just over 11% annualized during the first quarter. This is the lowest rate that we have experienced since 2003 and reflects our continued efforts to make Cognizant a terrific place for people to work.

In addition to hiring new associates, we continue to proactively manage our growth through investments in training and leadership programs for staff at all levels. Cognizant Academy, our in-house training and development division, continues to support the advancement of our people. We know that our ability to quickly train and retrain our associates is key to our ability to manage our growth. To give you some sense of our training efforts, during the quarter Cognizant Academy delivered almost one million hours of classroom training, both to new recruits and existing employees. In continuing with our drive to get our associates around the world certified by externally recognized independent bodies, our employees receives about 880 external certifications in the first quarter. These certifications covered a range of areas including industry domain certification, project and program management certification and various external technical certification.

We also recently launched two important Company-wide leadership development programs to focus on the crucial development of our management talent and our client relationship management talent. High 5, our leadership development program, reflects industry-best practices for high potential leadership development. High 5 is focused on developing leaders through career movement, coaching, training and external education. Closely linked to High 5 is our Relationship Management Center, the RMC, which seeks to develop individuals who help create the Cognizant client experience. Cognizant's relationship management -- managers are key to our business model and our continued ability to grow the business. As such, RMC is a continuing education program to ensure that these critical individuals have the core skills, knowledge, and style to be effective. Perhaps most importantly, the RMC seeks to ensure that the Cognizant customer experience is uniform across the Company.

The third operational focus during the quarter was our continued investment in expanding our geographical presence to meet our clients needs, irrespective of where they operate. We believe that having the right people in the right locations around the world will support our growth over the long-term. For example, Europe is clearly awakening to the offshore trend. with emerging demand for high-level application development, maintenance and BPO work. We continue to make local hires throughout Europe and have also redistributed senior talent from other parts of the world to build strength in Europe. We now have strong team dedicated to our horizontal and industry vertical businesses located in most major geographic markets of Europe. This expanded presence has enabled us to secure a number of wins in Europe, including one key strategic win in continental Europe in the manufacturing sector during the first quarter. The scale of our operations in India, North America and Europe, coupled with our gradually expanding presence in China, ensure that we are able to meet the needs of the largest and most sophisticated companies across the globe.

So sum up our progress in the quarter, we are continuously building out our infrastructure, evaluating and implementing strategies to expand the range of our talent, augmenting our geographic markets and enhancing our management processes to better serve our clients and sustain our growth.

With that I would like to turn the call back over to Lakshmi. Lakshmi?

Thanks, Franc. As I said earlier, we very pleased with our strong start to 2006. We recognize that our financial success to date and industry-leading rate of growth is dependent upon both the consistent execution of our strategy and our steady focus in the investments we are making in the business to sustain our momentum. The foundation of both of these continues to be our customer-centric focus, which shapes our corporate culture, our operations and our investments. We are clearly benefiting from the increased discretionary spending by our customers. We believe that, as the market increases its technology spend to gain a competitive advantage, we will get a fair share of the increased spend.

With that, I'll request Gordon to take us through the numbers in detail. Gordon?

Thank you, Lakshmi, and good morning to everyone. I'd like to spend some additional time on the first quarter and then discuss our financial expectations for Q2 of this year, as well as full year 2006. Revenue for the first quarter significantly 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 11% sequentially and 57% year-over-year. As the quarter proceeded, we continued to see healthy volume growth across a broad range of services and industries.

Our core businesses remain vibrant and our pipeline is robust. During the quarter, our financial services segment, which includes our practices in insurance, banking and transaction processing, grew by more than $46 million year-over-year and represented 48% of revenue for the quarter. Healthcare grew over $27 million and represented 22% of revenues. Retail manufacturing and logistics grew by over $9 million and represented 16% of revenues. The remaining 15% of our revenues came primarily from other service-oriented industries in the telecom, media and new technology areas. Financial services grew 51% year-over-year and 5% sequentially. Healthcare, as Lakshmi mentioned earlier, grew 77% year-over-year and 16% sequentially. Growth in our healthcare segment was a particular -- was, in particular, driven by numerous life sciences clients that we have won recently and are now ramping-up. Retail manufacturing logistics grew 25% year-over-year and 12% sequentially, and other our segment grew 103% year-over-year and 26% sequentially. Growth in the other segment benefited from growth in telecom, media, new technologies and our alliances, as well as on a year-over-year basis the acquisition of Fathom in April 2005.

For the quarter, application management represented 49% of revenues and application development was 51%. Both services grew significantly in Q1. On a year-over-year basis application management grew 49% and application development grew 66%. On a quarterly sequential basis, management grew 9% and development grew 13%, reflecting the strong demand environment for our service offerings. Within our maintenance and development service lines, we were particularly pleased with the interest shown by our clients in our specialized services, as well as our ability to meet this demand. Our ERP and CRM practice grew by over 100% combined on a year-over-year basis. Our data warehousing practice, which we believe is the clear leader in our industry, also grew by approximately 100%. And finally, our testing practice grew by approximately 140%. Each of these practices represented approximately 10% or more in total revenues in the quarter. In addition, our infrastructure management practice, advanced solutions group and BPO practice all grew at rates faster than the Company average.

During the quarter 87% of our revenues came from clients in North America, Europe was 12% of the total, and the remaining 1% of revenue came from the Asian market. Our European business grew 22% sequentially, well above the Company average, as we continue to invest in that region. We added 32 new customers during the quarter. We closed the customer -- we closed the quarter with an active customer base of approximately 260 clients. During the quarter, across our verticals and geographies we added five accounts which we consider to be strategic and have the potential to become significant revenue sources for us in the future, bringing our total number of strategic clients to 72. We ended work for approximately 19 clients during the quarter, almost all of this were very small clients.

Turning to costs, on a GAAP basis, cost of revenues increased 62% for the quarter as compared to the first quarter of 2005. On a non-GAAP basis, which excludes the impact of equity-based compensation, cost of revenues increased 59%. The increase is due to additional technical staff, both on-site and offshore, required to support our revenue growth.. We increased our technical staff by approximately 2,300 people during the quarter, and ended the quarter with approximately 25,000 technical staff. This is a net increase of over 9,000 technical staff from March 31, 2005. Gross margin was 44.4% for the quarter on a GAAP basis. On a non-GAAP basis, which excludes the impact of equity-based compensation, gross margin in Q1 was 45.6%, a decline of 150 basis points sequentially and a decline of 50 basis points compared to Q1 of last year. On a sequential basis, gross margin was negatively impacted by items such as the sequential appreciation of the Indian rupee, the seasonal impact of FICA in the U.S., an increase in employee health benefit cost accrual, and a bonus accrual in Q1, well above targeted levels due to our strong performance and desire to share our success with our employees.

SG&A expenses, including depreciation, were $73.7 million on a GAAP basis, up from $46.5 million in the first quarter of 2005. GAAP SG&A expense in Q1 of this year included approximately $4.5 million of equity-based compensation expense. As percentage of revenues, GAAP SG&A was 25 8% for the quarter. Non-GAAP SG&A was 24.3% of revenues, down 130 basis points from the first quarter of 2005 and down 290 basis points sequentially from the fourth quarter of 2005, a quarter in which we had unusually high costs in certain areas including marketing, integration and employee reward and recognition programs. GAAP operating income for the quarter increased 43% to $53.2 million from $37.2 million in the first quarter of 2005. On a non-GAAP basis, which includes the impact of equity-based compensation, operating income for the first quarter was $60.8 million, up 63% from last year, and our non-GAAP operating margin of 21.3% significantly exceeded our target operating margin range. With salary increases effective in Q2 and a significant acceleration in investment spending, we expect our non-GAAP operating margin for the remaining quarters of this year to be back within our target range.

Interest income for the first quarter increased to $3.4 million compared to $1.8 million in the first quarter of 2005. Interest income increased due to a higher global cash balance, as well as increase in short-term interest rates. We had a $41,000 dollars foreign exchange loss during the quarter. Our GAAP tax rate for the first quarter was 16.6%, and the non-GAAP tax rate, which excludes equity compensation costs, was 16.4%. Our tax rate for the quarter and expected rate for the full year is slightly lower than our prior guidance due to a higher-than-forecasted portion of our expected full-year earnings to benefit from the tax holiday in India. This is a result of our increased revenue and earnings expectations for the year.

Turning to the balance sheet, our balance sheet remained very healthy. We finished the first quarter with approximately $422.5 million of cash and short-term investments, up over $108 million from March 31st of 2005 and down slightly from December 31st of last year. During Q1 sequential cash flow was negatively impacted by the increase in DSO, as well as 2005 bonus pay outs. During the first quarter, operating activities used approximately $4.4 million of cash. Financing activities, primarily the exercise of stock options, generated $22.7 million of cash. These amounts were partially offset by approximately $20.1 million of capital expenditures, including expenditures on our India construction program. In addition, we generated approximately $400,000 due to currency translation adjustments.

Our collection of trade receivables during the quarter was healthy, given certain Q1 seasonality. Based on our $218 million balance on March 31st, we finished the quarter with a DSO, including unbilled receivables, of 69 days compared to 65 days for the same quarter last year. The number of billing days, as well as da -- as well as our daily volume during the quarter was skewed towards March, negatively impact our DSO compared to the fourth quarter of last year. During Q1, excluding unbilled receivables, our DSO was approximately 58 days. Quality of our receivable it is portfolio remains very strong. Our unbilled receivables balance was approximately $33 million at the end of the first quarter, up about $14.6 million from March 31st of last year. The increase in unbilled receivables resulted primarily from the timing of billing milestones and the volume associated with our continued revenue growth and shift towards development projects. Approximately 50% of our March 31st unbilled balance will be billed -- or was billed in the month of April. During the first quarter, overall 25.9% of our revenue came from fixed-bid contracts, up from 25.7% in both the first quarter and fourth quarter of 2005. 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.

Turning to head count, at the end of the first quarter our worldwide head count, including both technical professionals and support staff, totaled approximately 26,750. This represents a net increase of over 2,400 people for the quarter and approximately 9,700 people compared to March of last year. Approximately 50% of our Q1 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 our ongoing success in recruiting, we currently expect to exceed 35,000 employees globally at the end of 2006 and have the capacity to add staff in addition to that. if necessary, and we are moving well along towards this goal. Turnover, both voluntary and involuntary, was just over 11% annualized during the first quarter. As Francisco mentioned, that is our lowest rate since 2003. On-site utilization remained around 85% for the quarter. Offshore utilization, excluding recent college graduates who were in our training program, was approximately 69%. Including trainees, offshore utilization was approximately 53% for the quarter. We had approximately 2,500 unbilled people in our training program at the end of the quarter.

I'd now like on comment on our growth expectations for Q2 as well as full-year 2006. As Lakshmi and Francisco mentioned earlier on this call, the investments we are making are producing results. The investment is allowing us to differentiate ourselves from our marketplace, both in terms of winning and growing new clients and expanding our service offerings. In addition, our client and employee satisfaction levels remain at a level at which we are proud. This has resulted in stronger-than-expected Q1 results and is allowing us to increase our full year guidance for 2006. We are now projecting revenue for the second quarter of 2006 of at least $317 million. This represents 11% sequential growth and 50% year-over-year growth. As a reminder, our sequential growth in the second quarter of last year, 2005, included the contributions from our acquisition of Fathom, as well as a 3% sequential increase in billing days compared to a flat number of billing days sequentially in Q2 of this year. 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 well over 90% of our second quarter revenue guidance.

For full-year 2006, based on the strong demand environment for offshore services and our favorable experience on ramp-up rates, we now project revenue to be at least $1.3 billion, up $40 million from our prior guidance. This represents growth of approximately 47% -- of at least approximately 47%. As has been typical in prior quarters, we expect the majority of our growth for the second quarter and full-year 2006 will come from 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 for the remaining quarters of this year to remain in the range of 19% to 20%, that's before the impact of equity-based compensation, in line with our historic margin level and prior guidance. To be clear, our operating margin targets exclude the impact of equity compensation expense. With this expected level of revenue growth and our expected operating margins, we are currently comfortable with our ability to deliver in Q2 GAAP EPS of $0.33 and non-GAAP EPS of $0.36, which excludes equity compensation expense.

This guidance includes the anticipation of a Q2 share count slightly more than 150 million shares, a tax rate of 16.6%, and an operating margin in the upper half of our guidance range, excluding equity compensation. Based on current business trends, we are increasing our expected GAAP EPS guidance for the full year to at least $1.37, up from our prior guidance of at least $1.30, and full-year non-GAAP EPS of at least $1.52, which excludes equity compensation expense, up from our prior guidance of at least $1.43. This guidance includes the anticipation of a full year share counted of approximately 151 million shares. In addition, this guidance assumes a tax rate of 16.6% and a full year operating margin at the top end of our 19% to 20% guidance range, excluding equity compensation expense. We expect a vast majority of our Q2 and 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 of continued industry leading growth.

Operator, we'd now like the open the call for questions.

[OPERATOR INSTRUCTIONS] Your first question comes from Rob Brugge with Bernstein.

Great. Good morning, you guys. Gordan, can I ask you a question about the margins? You said your margins exceeded your 20% target range. What will cause margins over the remaining quarters of the year to come back down? Are you going to take the liberty to invest in growth, lower utilization, what's the factor that's going to bring margins down for the remaining quarters?

There's several things. First of all, our wage increases go into effect in April, so that'll impact margins. And I'll come back and we can talk about the levels there. Second, we are significantly accelerating our investments in everything from geographies to adding to management to building out our industries and verticals. We clearly have an opportunity to continue to take market share, and our strategy is to invest at the above 20% non-GAAP operating margin to drive long-term sustained above industry level growth. On wages, wage inflation for this year is coming in exactly where we planned. We're expecting offshore wage increases in the very low double-digits and on-site wage inflations in the very low-single digits, so we're not seeing any surprises there. It's exactly what we planned; but, obviously, that does have impact on margins on a sequential basis.

Maybe Lakshmi would like to comment a little more on why we're seeing wage inflation, very different than what you're hearing from many others in the marketplace.

Let me add to what Gordon was saying as far as the wages and the attrition, and I'll just mention, in terms of attrition, we had the best quarter so far. The three reasons that contribute to greater retention are the ability to manage the wage increase. First and foremost, its the growth. Because of the higher-than-expected growth and higher than the industry growth, we're able to provide greater growth opportunities for our people within the organization. We have seen significant number of promotions under our empowered culture. Our people like the way that they're taking greater responsibilities, number one. Number two, I also talk about the increase in the application development work, or the discretionary spending. This is exciting work. This is new technology work. This is challenging work that excites the people as they get to work on some of the leading technologies and products. And finally, our philosophy of variable compensation and the philosophy of better the performance, better the pay, has been well understood by the entire organization. For example, last year we shared a substantial portion of our [inaudible] performance through the bonus of the incentives scheme. We paid well above the target bonus. And given our performance so far, we expect to continue to pay a higher variable component or a higher bonus. Given all of which, we are able to manage the wage increase offshore at the low double-digits and on-site, which is U.S. and Europe, at the low single-digits.

Great. Well, you answered the second part of my question about why your turnover and wage inflation is not the same that you're seeing at your competitors. You hit a positive inflection point in Europe. That business was somewhat lagging, relative to the rest of your business, but I think you said you did 22% sequential revenue growth. What caused that inflection point in the acceleration in Europe and is that likely to be some of the tail wind that carries you through the rest of the year?

Yes, this is Franc. Let me try to address that. You're right, Europe grew 22% sequentially and about 49% year-over-year. And we said in the past what we're start to go see is that companies in continental Europe, in particular, are starting to adopt the offshore model, and we're pleased this quarter our growth -- the growth number that I mentioned were nicely balanced between both the U.K. and continental Europe, so we're seeing both these markets picking up nicely. The unknown factor at this point is what impact on our growth labor regulations and cultural issues in continental Europe will ultimately have. We are, as I mentioned, building a strong team in continental Europe through a combination of local hirings and internal transfers from other parts of the Company, and so we're looking forward to continued growth in Europe in the coming quarters.

Great.

Thanks, Rob.

Thanks.

Your next question comes from Ed Caso with Wachovia Securities.

Good morning. Thank you. I was sort of curious, given the dramatic success you've had over the last several years with expanding strategic clients, why do you actually pick up nonstrategic clients every quarter? Is that to sort of learn new technologies on or what's the strategy there?

Yes, you mentioned part of the answer. Some of the other customers that we work with, they work with different products, different technologies, different models. By working with some of these customers, we understand the best practices from them, which we are able to apply in all the relationships that we have. There is a tremendous learning that happens by working with all the customers.

My other question is on a lot of your competitors offer dividends and you have a significant cash position at this point. What are your plans for both share repurchase and a possible dividend?

As I've discussed with investors, first of all, having a healthy cash balance is very important, as we're now winning very large deals. Not because we've used the cash as part of winning the deals, but customers are betting their businesses on us, and they want to know we're going to be around for the long-term. So we want to continue to have a healthy balance sheet. In addition, we do small acquisitions. The definition of small changes, obviously. We used to do -- as we get bigger, it no longer makes sense to say a $2 or $3 million acquisition. The last one we did, I think, was $35 million cost or so, so we use some money on acquisitions. And then, finally, we want to have the ability, if there are opportunities in the marketplace due to external events that either impact our stock or other stock, to have that flexibility. So near-term, no change in our strategy for use of cash.

Thank you.

Your next question comes from Joseph Vafi with Jefferies & Co.

Hi, gentlemen, good morning. Great quarter. I was wondering if we can talk a little bit about the strategic customers that you signed in the quarter relative to maybe penetration in the different verticals. Clearly, financial services is probably the biggest adopter and has become the most mature vertical. What are you seeing in terms of other verticals and also the maturity of financial services as a ground to find new strategic customers moving forward?

Joe, you're absolutely right. What we've seen this quarter and you sort of have seen in past quarters in 2005, less so prior to that, is our wins are becoming much more diversified. Our pipeline's becoming more more diversified, as industries beyond just financial services now look at offshore strategically. A perfect example is pharmaceutical. A couple years ago, really very little interest in offshore. Now as we mentioned, we're doing work for seven of the top pharmaceutical companies in the world, so I think this is a trend that you're going to continue to see of diversification of our client base. Now, do not read that as financial services is maturing. We still have tremendous growth opportunities there. We continue to win strategic clients there. But, it's now, in addition to that, we have lots of other pockets that we're going after.

Let me add to what Gordon was saying, just one point about the financial services industry. They are the aggressive adopters of technology. They spend a substantial portion of their revenues on new technology, and that's a great opportunity for us to continue the growth there. There's one other industry I mentioned, very specifically. That's the media and the entertainment industry, and that's something that is just awakened because of this outsourcing and offshore outsourcing. And combined with telecom, where there is this convergence that's happening, that presents an good opportunity for us to deliver some high-end technology solutions to that new industry. So, these are the ones that are contributing to the growth and expect to continue that.

Okay. That's helpful. Drilling down into the development business, which is clearly doing better, maybe we could get some color on looking at that development market now, say versus a year ago or maybe 18 months ago, and your ability to go after a larger piece of the pie in the overall development market because your skill set has advanced and you're competing on different types of business and you hadn't been a year ago. And we can get a feel for where that growth might be coming from, a larger overall addressable market versus just a strength in an overall market?

I will try and give you two data points, as far as the development effort is concerned. First one, as it relates to integrated application of solutions, which includes packages -- you know, essentially the system integration type of work -- we announced some work that we do with the safety and some of the other ERP products. And then there is the new NetWeaver® platform, which is something that is being increasingly adopted by customers. That's the new type of work that is taking place in the market place, one. And the second point is, in addition to the development work that we carry out, there is a whole lot of development that corporations are carrying out, either using their own in-house tasks or other partners, and we get to participate in those activities through our testing. Testing, as you know, is one of the fastest growing horizontals in Cognizant, and we have grown that practice several forward in the last quarters. These two are examples of what contributes to growth to the development sector.

Okay. And then just, Gordon, on top five and top ten and maybe some comments on maturity of those customers in your view of those, moving forward?

Certainly, just give me one second. The top five customers was 30% of revenue in the quarter. Now if you do the math, you'll see that's actually down in terms of dollars sequentially. That was fully expected, as a couple of the customers we had the projects winding up. We do not view those customers as mature and we actually expect very healthy sequential growth in Q2, so it's just sort of an anomaly within the quarter on projects. But the growth continues to be very healthy among the top five, as we look into Q2. Top ten was 42% of revenue, which was about a 3% sequential increase. And, obviously, overtime the top five and top ten, as we've discussed, will come down just because we have more customers outside of the top five and top ten.

Thanks so much.

Your next question comes from Christine Pezino with JPMorgan.

Good morning. Just a few questions here. You mentioned that Europe is strong and the up-take in offshoring in Europe. Can you talk about specific areas in geographies in Europe where you're seeing maybe the strongest demand, whether it be France, Germany, Netherlands, UK, et cetera?

Yes, hi, it's Barry. Let me try to put color on that. Clearly the UK has been our historic area of investment and it's been where we currently have the strongest presence and the adoption of offshoring is probably the most mature of all the markets in Europe in the UK. That's largely around -- or I shouldn't largely, but a big factor there is the language being English and, of course, helps with the India offshoring. In terms of continental Europe, in our particular case we're seeing traction in many markets in continental Europe. I would specifically point out the Benalux. As a result of an acquisition we had done there some years ago, we're now beginning to see traction in Benalux and also Switzerland. Those are the two markets that I would point to in continental Europe. I think France and Germany, from a Cognizant perspective, are -- we're beginning to see signs there of interest, but it is still early days.

Okay, great. You talked with discretionary -- increased discretionary spending kind of boosting the application development business. Can you talk a little more about what you're seeing there? Is it just larger IT budgets generally or existing customers reinvesting some of the savings they've yielded from offshore or just more spending being directed towards offshore or probably all three?

It is more of the second point as you mentioned, that the overall cost of maintenance keeps coming down, they're reinvesting the saved dollars on new development initiatives with us. That I would consider is the primary reason for the increase in development of the discretionary spending. In addition, many of our customers experiencing good growth in various sectors because of which they're able to increase the budget and some of have comes to us a development initiative.

Great. One last question on the operating margins. As you continue to grow at these above-industry average rates, do you see a point where you won't be required to make the same investment in the business on a percentage basis, and how long will you continue to grow at these rates and keep the operating margin kind of steady state?

Christine, this is Gordon. Because the business is somewhat unique and it's very much a long-term relationship business, not go in and do one project and then leave. The name of the game here is while the market is wide open to win as many clients as possible and invest to ramp them up as quickly as possible. So our strategy is to take anything above 20% non-GAAP and use that to grow faster than others in the market place because we believe, on a long-term basis, that's what's going to drive shareholder value. Obviously, there's to be a quarter or two where we just couldn't spend the money fast enough. Q1 was an example of that. Obviously March came in very strong and we couldn't crank the spending up fast enough. We're fully committed to taking anything above 20% non-GAAP and putting it back into making sure our employees are satisfied, our clients are satisfied and, most importantly, we deliver on that special Cognizant client experience that Francisco mentioned. In the end, that's what it comes down to and we're putting the money there and it's paying off. We are growing our relationships faster than others.

Thanks. Good quarter, guys.

Your next question is from George Price with Stifel Nicolaus.

Thanks very much. Just a couple of follow-up's. First of all, Gordon, on the operating margin issue, you mentioned some SG&A costs that were a little bit higher than expected. Was there any -- you know, did the operating margin float up in any way sort of to offset any of that? Was that thinking or was it just purely the timing and the strength of the revenue?

George, just, just be clear, the SG&A expenses in Q4 of last year were higher than normal because of the couple items that I mentioned and came back to a normalized level in Q1. What happened in Q1, until we got into the latter part of the quarter, internally we didn't realize how -- see strong revenue was going to be, because we really had a very strong surge in March. So at that point, we cranked up the SG&A spending, but it takes a little while for it to really crank and that's why we're saying Q2 will be back to a normal level, but we couldn't get back to a normal level in Q1.

Okay, I'm sorry. I misheard you. On the competitive landscape, maybe if you could give a little bit more detail inside around what you're seeing from some of your other offshore players -- offshore competitors. Given the margin pressure and the wage pressure that some of them are seeing, maybe are there any changes out there in the competitive dynamics of the industry that are evolving and also maybe how the multinationals are doing?

In terms of the competitive landscape, there's one factor that's important, the clear separation between the tier 1 players and the tier 2 and the tier 3 players. This separation started happening about three or four quarters back, and that seems to be strengthening. That gives us the opportunity to hire people from some of the other companies into our fold. That's one opportunity that the people, in terms of the competitive -- the positioning in the market place, clearly the tier 1 players will get a greater proportion of the projects, of the wins, compared to the other tier 2 companies. And as far as the [inaudible] corporations are concerned, clearly a number of them are investing in India, expanding. And there is a reasonable amount of competition for the resources there. From a Cognizant perspective, since we enjoy a good reputation in the academic institutions, which is where we hire the bulk of our people, anywhere between 65% to 70% of the new hire will be fresh out of engineering college and business schools. And we have a good program going. And for this year, we have a lock on all the resources that we need, based on the campus hirings that we did last year. And we have a plan that's in place to go and lock in these resources for next year's [inaudible]. Doesn't appear to be too much of a problem.

And I might want to add just one last point. We talked about the wage increases. There is very little wage pressure at the entry level and there has been no significant change in the compensation, because there's a large number of people that are graduating out of these colleges. We can dig deep and get them, and because we have a very robust and strong training program and development program, we are able to get them to speed and contribute to the development activities fairly quick.

Okay, and just last thing, maybe a comment on if there's been any changes to the pricing in the industry -- continue to hear sort of stable with an upward bias, it's a pretty often used term. But what you're seeing, maybe new business coming on, if sort of blended pricing how that might be impacted by how the mix of your business is shifting? And then, Gordon, if you could remind also on a wage -- on a percent basis, what percent of the overall cost base is on-site versus offshore wages? Thanks.

Sure, George. First of all, we sound like a broken record, but I think you summarized it just right. The price is stable with an upward bias. Our pricing was up very slightly from Q4 and we think we're about right in our planning assumptions for the full year, which was about 1.5% on a blended basis. You know, that includes the impact of moving towards larger customers, on the negative side, on the positive side some of the higher value services. And you're absolutely right, we haven't seen any change in the belief that it's stable with upward bias. In terms of wages, about 17% to 18% of our costs -- of our total costs are India wages and about 55% of our total costs are on-site wages. And as I mentioned, wages came in exactly where we planned for and budgeted for, so no surprises there.

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

Thank you, sir. Your final question comes from the line of Julio Quinteros with Goldman Sachs.

Question in ten parts? [LAUGHTER]

And you'll start with the fifth part, right?

I'll start with the first part. Francisco, actually I just wanted to start with you. Can you maybe just give us a sense on just the operations. What is different about the way that you guys are executing right now versus your competitors and maybe if you can just point to one or two things that will help us get our arms around the out-performance? And then just the last question that I actually have was actually for Gordon, if could just sort of break up the gross margin impact on the issues that you highlighted? I think you highlighted rupee and wages. I just wanted to get a sense on what the impact was on sort of a basis point perspective.

Yes, I think the -- what I'll point to here is what we called on this call the Cognizant customer experience. For some time now we've been talking about the fact that we're continuing to reinvest at the customer interface. We've put a lot effort, energy and dollars behind that, and that's really, I think, the single point of differentiation. We are servicing a smaller number of clients, servicing them very deeply. Investing really -- very heavily at the client interface. And what's happening is that, as the services that we're performing for clients are becoming increasingly more sophisticated, as we are getting into the discretionary spending, the development that Lakshmi talked about, the systems integration work. These are more sophisticated capabilities that require a deeper level of engagement at the client interface. We're very well positioned there to take the client through both the technology, but also the business change issues that are involved in those types of sophisticated programs. And I think that's probably the most important thing that's allowing us to scale client relationships. Because as client's get more comfortable moving more sophisticated work offshore, our client partners, our industry experts, our program manager, our project managers are all there to surround the client to provide them with a very seamless Cognizant experience.

Francisco, do you have maybe a specific number then, or some percentage that you could give us that -- just to sort of demonstrate the difference? May percentage of MBA's within your billable work staff versus maybe the industry norm. Do you guys have a sense on what that would look like?

At this point, Julio, we have about one MBA for 25 to 30 technologists. It's roughly in that order of magnitude. It's a very high percent of MBA's to non-MBA's and activity really helps with that Cognizant experience. And as I mentioned earlier in the call, in the first quarter we hired about 200 MBA's, which represented just under 10% of our total net hiring in the quarter.

Okay, great. Thank you.

And Julio, on your question of the break-up -- of the impactive of those, we don't provide a specific break-out. All of them had impact. The rupee, on average, by about 2.3% and as I mentioned in the past, each 1% movement in the rupee impacts operating margin, but most in [inaudible] gross margin is by about 20 basis points. As Lakshmi mentioned, we are accruing bonus in Q1 and expect to pay bonus for 2006 at a healthy level. You know, we share the success with our employees. And employee health care cost jumped up in Q1, as we start the new year in higher rates and you have to accrue for term of liability and all that kind of stuff. So that comes back down. And then FICA -- FICA's probably the least of the four items, but each one clearly has impact.

Okay, and then finally, just the CapEx projection for the full year?

Still projecting about $120 million. We spent about $20 million in Q1. A lot of it will end up, depending on exacting when we start construction building. But at this point, our view would be unchanged.

Have your construction plans changed at all or are you guys still on target with those?

It's always moved around. Some stuff accelerates, some decelerates and a lot of it ties to getting approval for special economic zones, so it's a shifting playing field. But at this point, no dramatic changes in the overall plan. Where exactly building may be built is always fluid for the industry.

Okay, maybe if I could then just wrap up, Gordon, on the second half of the year, obviously there's a -- in the implied guidance there's a little bit of a deceleration. Is that just a little bit of caution that's conservative that's on your part given the kind of growth that we're seeing now or is there something more in line -- or something more that we have to think about terms of the seasonality of the second half of the year with September-December being more -- I guess there'd be more holidays and probably be more cutbacks to factor into the economics in the second half?

Clearly -- clearly there's a seasonality impact in Q4 and normally it's Q1 and Q4. And if you kind of rank it, Q2 tends to be the strongest then Q3 and then Q1 and then Q4. But without a doubt you have a seasonality impact in billing days in Q4, less so in Q3.

Okay, great. Thanks, guys.

Thanks, everyone.

At this time I'd like to turn the conference back to Lakshmi for closing remarks.

Thank you, and in summary, our strong financial performance in the first quarter is going to build up substantial growth across our broad range of industry verticals and service offerings. We are confident that this strategy will drive our future success. And thank you for participating in this call.

Ladies and gentlemen, this concludes today's conference. You may now disconnect.