高知特 (CTSH) 2006 Q2 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 second quarter 2006 earnings conference call. [OPERATOR INSTRUCTIONS] I will now turn the conference over to Ms. Julie Prozeller with Financial Dynamics. Ms. Prozeller?

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

Thank you, Julie, and good morning, everyone. Thank you for joining us today for our conference call. Today we will discuss Cognizant's second quarter 2006 earnings and the management's succession plan, both of which we announced this morning. I'm joined this morning as usually by Francisco D'Souza, our Chief Operating Officer, and Gordon Coburn, our Chief Financial Officer. We are pleased with the financial performance of Cognizant in Q2. And are very happy about the executive level promotions that we announced leading to the management's succession plan. Let me start by discussing the management succession plan. As you are all well aware, our strategy has always been focused on making ahead of the curve investments to insure that our organization can support our aggressive growth trajectory. Today we have announced a further investment in Cognizant's future, to take us to the next level as a mighty billion dollar Company.

After careful planning and with the support of the board of directors, today we announced that I'll be taking on the new full-time role of Vice Chairman of the Board and our Chief Operating Officer, Francisco D'Souza, will take over as President and CEO, effective as of January 1, 2007. In addition, Gordon Coburn, currently Chief Financial Officer, will be promoted to Chief Financial and Operating Officer. During more than a decade at Cognizant, Frank has played an integral role in building our client relationship management, sales and marketing, and global delivery organizations into world class operations. Frank is widely recognized in the industry for his strategic vision and operational excellence, which are two strengths fundamental to Cognizant's ability to achieve it's financial and operational goals and continue it's industry-leading growth. I look forward to working with Frank over the next several months to ensure a smooth transition of my responsibilities as CEO. Once the transition is complete, I will remain closely involved in my role as Vice Chairman of the Company.

As we have grown beyond $1 billion in revenue and have become a tier one industry leader, it has become clear that we need to formally devote time and attention to many industry issues which impact our firm. In the roll of Vice Chairman, I will focus on these issues. For example, acting as Cognizant's advocate to various industry organizations, such as NASSCOM where I currently hold a leadership position, work with education institutions to double up the faculty, [asking] the students to be industry-ready and so on. I continue to work alongside Frank in further strengthening the Cognizant brand and mentoring our next generation of leaders. Gordon Coburn, in his new role of Chief Financial and Operating Officer, will continue to lead the Company's financial operations, while taking on additional global responsibilities for enhancing Cognizant's cross-business unit processes and capabilities in areas such as talent, infrastructure and systems to support our continued growth.

Gordon has been an invaluable member of the executive management team since the early years of the Company and I'm confident that he'll continue to be a strong leader and successful in his expanded role. Frank's current responsibilities will be divided between two seasoned Cognizant veterans who intimately understand our history, culture and the ingredients to our success. Chandra Sekaran , who has been an executive officer of the Company since 2004, has been promoted to President and Managing Director Global Delivery and will oversee Cognizant's development operations around the world. Rajeev Mehta, who is being added to the executive team as Chief Operating Officer Global Client Services, will assume responsibility for the Company's sales, business development, and client relationship management organizations. Both Raj and Chandra have been instrumental to Cognizant's success over the last decade.

Chandra has been with Cognizant for the past 12 years, serving most recently as Executive Vice President and Managing Director. During this time, he has demonstrated exemplary leadership capabilities and managed many aspects of the business, including offshore delivery, key alliances, capacity growth, process initiators and business development. Chandra has played a key role in growing the employee base from about 200 to more than 20,000 in various development locations in India and nurturing the culture of Cognizant. Raj, who joined Cognizant in 1997, most recently served as Senior Vice President and General Manager of Cognizant's Financial Services business unit, leading the group, the largest within Cognizant, to recognize industry leadership. In his capacity he has been responsible for sales, business development, planned relationship management and full P&L management. I'm confident that this expanded executive team, which has worked together over the last several years to build Cognizant, is the right team to maintain our industry leadership going forward, both in terms of stature and performance.

Now turning to highlights of the second quarter, we are very pleased with our strong financial performance, which spanned all elements of our business, across our industry verticals, service offerings and customer markets. We have continued to see substantial sequential and year-over-year revenue growth from our leading verticals, which are financial services, healthcare and life sciences, two newer industries like telecommunications and media. We were also very pleased with the solid performance of our entire portfolio of service offerings in the second quarter. We posted healthy double digit sequential growth in infrastructure management, testing, data warehousing, advanced solutions, customer relationship management and ERP, based on escalating demand for our services. What's more is that we continue to see growing demand in newer customer markets, particularly Europe, where I'm pleased to report that growth this quarter exceeded the Company average.

Looking at our second quarter results in detail, we exceeded our guidance to investors, generating $336.8 million in revenue, which was 20 million above our guidance and represents an increase of 59% from the second quarter of 2005. GAAP EPS was $0.37 for the quarter, up from 32 last quarter. Non-GAAP EPS, which excludes stock-based compensation expense, was $0.41, compared to 25 in the second quarter of last year. We also added a total of 36 new clients in the quarter, five of which are considered strategic, which means that we think they have the potential to generate between 5 and 40 million or more in annual revenue for Cognizant over the long-term. Our GAAP operating margin was 18% and our non-GAAP operating margin was a very strong 20% at the top-end of our long-term target range of 19% to 20%, even though we continue to make strategic investments in the future growth of the business. I'm very pleased with our financial performance during the first half of the year.

Our ability to produce consistently strong financial and operating results continues to demonstrate the success of our strategy, our ability to sustain our momentum, and outpace the market going forward. As Cognizant accelerates beyond the $1 billion annual revenue mark, we continue to focus on investing in the business to maintain our industry-leading growth. We recognize that our success would not be possible without the consistent dedication and high quality of work from our employees at every level of the business around the world. We continue to focus on bringing the best minds to Cognizant and maintaining the highest standards of performance through significant investments in campus recruitment, talent management, develop and leadership training programs, which I'd like to tell you about in a little more detail. Touching on campus recruitment, in the second quarter we increased our headcount by 11% sequentially, adding a net of over 2900 employees.

Cognizant visits approximately 150 engineering institutions across India and we strive to differentiate ourselves early on by reaching out to college juniors through our unique campus ambassadorial program, in which Cognizant alumni shared they experiences with students. In addition we continue to enhance our recruitment efforts by re-evaluating salary levels in order to ensure that our offers to prospective employees are very attractive and in line with industry averages. To this end, we recently increased entry-level salary offers by 20% for graduates who will be joining us during the 2007 season and have already seen the benefits of this in our recruitment efforts. It's important to note that our wages have remained within the range we have predicted. Another important aspect of recruitment is talent management and development, which allows us to quickly train and retrain our associates and is integral to our ability to scale our operations while managing our growth. Through our in-campus program, we work with top universities to make courses available to jump-start training before new hires even leave the campus.

More than 6,000 new hires will go through the program this year and we expect these number to increase substantially next year. We also focus on training and development in house through Cognizant Academy, which we have continued to expand as we grow the Company. Recent initiatives have enabled a true blended learning approach to both our managers and our associates, using a combination of E-learning, pod casts, discussion forums, virtual classrooms, and physical classrooms to deliver training. These resources have dramatically increased the effectiveness of our learning programs, while giving our associates increased flexibility to broaden their skills. We also engaged in some very innovative initiatives like assisting finishing schools, implementing faculty development programs in the coaching lecturers and professors in universities to work collaboratively with Cognizant. I would now like to turn the call over to Frank, who will give color on some of the operational highlights in the quarter and the emerging growth area [INAUDIBLE] of Cognizant.

Thanks, Lakshmi, and good morning, everyone. First I would like to say that I'm honored that the board has appointed me to lead Cognizant beginning next year. I'm looking forward to working with Lakshmi during the transition and on an ongoing basis as we continue to grow Cognizant. I have had the privilege of working closely with Gordon, Chandra and Raj over the last decade to build the great Company we have become today. And I am confident that this team will further strengthen the platform we have in place to deliver significant value to our customers, employees, and shareholders going forward. As Lakshmi mentioned, I'll briefly discuss several of the key operational highlights of the quarter before turning the call over to Gordon. During the second quarter we continue to generate momentum across our vertical businesses, particularly in our industry-recognized leading verticals, financial services, healthcare and life sciences.

We further expanded our strategic customer relationships by leverage our deep industry expertise to align our client IT investments with their business processes and strategies to make their businesses stronger. Healthcare and life sciences posted 17% sequential growth and 85% year-over-year growth respectively. We also further expanded our leadership position in our financial services vertical, generating 20% sequential revenue growth and 56% year-over-year growth. During the second quarter, we also saw strong demand in our emerging verticals, particularly in telecommunications and media and continue to see growth in manufacturing and logistics. In telecommunications we are experiencing strong demand for our business intelligence services and in media we are seeing strong demand in particular areas such as digital asset management. With our manufacturing and logistics clients we continue to see strong demand for our enterprise solutions, including ERP implementation and maintenance and regulatory compliance solutions.

As Lakshmi mentioned, demand for Cognizant's major service offerings continues to grow. In particular, we have benefited from clients investment in strategic ERP and CRM initiatives. Our partnership with SAP continues to drive significant traction across industries such as manufacturing, pharmaceuticals and banking. In particular, our deep knowledge of the next generation NetWeaver platform, through Cognizant's NetWeaver test center, has enabled us to win several strategic relationships with global customers, including complex, large-scale implementation, program management and multi-year support engagements across North America and Europe. As we said in the first quarter, we continue to see more companies in Europe embracing offshore outsourcing. Specifically in Europe we are seeing solid traction across pharmaceutical companies for multi-year, multi-location support of their SAP systems that are governed by very stringent regulatory processes. And also greenfield implementation of SAP that requires a deep understanding of the molecules to the market pharmaceutical continuum across the three phases of drug discovery, manufacturing and sales and marketing.

For example, we are currently working with a large European company in the pharmaceuticals, chemical and plastics markets to redesign and re-implement their SAP systems, enabling the company to streamline their business processes across 11 countries in Europe. Another promising area of future growth for Cognizant is information technology infrastructure services. We are seeing increasing demand in this area as we have developed a suit of infrastructure management solutions designed to maximize the value of our client's IT infrastructure. Our services in this area include infrastructure monitoring and management consulting and systems integration and IT service desk solutions. Our integrated approach to IT infrastructure operations enables our clients to accurately and precisely measure IT infrastructure performance and service levels from the server room to the end user's desktop. Our consulting and systems integration services in this area include the areas such as performance optimization, offshore ability assessment, migration and consolidation.

We now deliver these services, which can be seamlessly integrated into our application level services, to an increasing number of customers across key verticals ranging from financial services and healthcare to telecommunications and media. For example, we are currently working with one of our long-term strategic clients in the healthcare industry to provide both applications and infrastructure management services for key applications that drive their business. Our ability to create a single solution covering applications and infrastructure for production systems has enabled this particular client to optimize business availability and increase customer responsiveness. Furthermore, infrastructure services continues to fuel the growth of our upcoming verticals such as media, where we recently took on responsibility for the infrastructure and IT operations of a leading New York-based publishing company.

Another major technology trend that we anticipate will be a driver of growth for Cognizant is the increasing adoption of service-oriented architectures amongst our customers. Through our SOA service offerings we address key areas such as business process reengineering, application integration, business collaboration, and services based information sharing. Our clients are seeking to gain competitive advantage by transforming their business processes to reduce operational costs, leveraging existing investments in IT assets and offering new and innovative services to their customers. Our offerings, such as right start SOA, and safe way SOA, accelerate and ensure that our customers planning and migrations to service-oriented architectures do not disrupt their existing IT ecosystem. A recent example of this work was just completed with Schwan's, the multi-billion dollar leader in the frozen foods industry. We worked with Schwan's to migrate their core business systems, comprised of 31 applications in all, off of the mainframe to a Microsoft.net environment.

This sizable program entailed replacing seven million lines of code and migrating over 900 gigabytes of data, all of which are used by more than 10,000 users at the company. Through this successful legacy modernization, Schwan's not only has a more efficient technology platform, but more importantly, has a full loosely coupled environment which provides their business with increased flexibility. In another example, we recently partnered with a leading global travel service provider, following a series of mergers and acquisitions, which left them with several siloed applications that were not reusable, interoperable or cost effective. By implementing a successful SOA strategy, Cognizant has been able to create the shared travel platform to increase synergies across their business units, improve responsiveness and time to market. As Lakshmi mentioned, one of our key strategic priorities is ensuring that we recruit the best and the brightest engineering and business school graduates to join Cognizant and support our future growth.

As a result of our efforts and the Company's strong reputation, Cognizant continues to enjoy a prime position in elite engineering and management institutions across India. Our ability to bring in the top candidates from among the best institutions has been very successful, thanks to our brand equity on the campuses and the strong relationships we have developed because of our industry-leading growth, open culture, non-hierarchical work environment, challenging assignments, and global mind set. This is evidenced by the fact that Cognizant continues to secure the first or second recruitment slots in the majority of the top engineering schools across India that we visit. These are just a few examples of the numerous areas of emerging opportunities for Cognizant and we will continue to invest in the people and the capabilities to fuel additional areas of growth to supplement our current strength. I'll now turn the call over to Gordon, who will take you through our numbers in greater detail. Gordon?

Thank you, Francisco, and good morning to everyone. I would like to provide some additional information on the second quarter and then discuss our financial expectations for Q3, as well as full year 2006. Revenue for the second quarter significantly exceeded our prior guidance and expectations due to continued application ramp-up of clients won over the past few years, significance knowledge transfer of additional application management projects, as well as continued greater than anticipated strength in development spending, a trend that started for us in 2003. Revenue growth accelerated to 18% sequentially and 59% year-over-year. During the quarter we continued to see healthy volume growth across our broad range of services and industries. Our core businesses remain vibrant and our pipeline is robust. During the second quarter our financial services segment, which includes our practices in insurance, banking and transaction processing, grew by more than $58 million year-over-year and represented 48% of revenue for the quarter. Health care grew over $33 million year-over-year and represented 22% of revenues.

Retail manufacturing and logistics grew by over 14 million, representing approximately 16% of revenues for the quarter. The remaining 14% of our revenues came primarily from other service oriented industries including telecom, media and new technology. Those industries grew by over $18 million compared to Q2 of last year. As Francisco mentioned, financial services grew by 56% year-over-year and 20% sequentially. Healthcare grew 85% year-over-year and 17% sequentially. Growth in our healthcare segment was, in particular, driven by the numerous life sciences clients we have won and are now ramping up. Retail manufacturing and logistics grew 38% year-over-year and 16% sequentially. And the other segment grew 62% year-over-year and 15% sequentially. For the quarter, application management represented 51% of revenues and application development was 49%. Both services grew significantly in Q2. On a year-over-year basis application management grew 58% and application development grew 61%.

On a quarterly sequential basis, management application management grew 22% and development grew 14%, reflecting the strong demand environment for our entire service offerings. Within our maintenance and development service lines we were particularly pleased with the continued interest shown by our clients in our specialized services, as well as our ability to meet this demand. Our ERP and CRM practices grew by over 125% combined. Our data warehousing practice, which we believe is the clear leader in the industry, also grew well above Company average. And finally our testing practice grew by approximately 125%. In addition, our infrastructure management practice, advanced solutions group, and business process outsourcing business all grew at rates faster than the Company average. During the quarter 87% of revenue came from clients in North America. Europe was over 12% of total revenue. And the remaining 1% of revenue came from the Asian market. Our European business grew 21% sequentially and 70% year-over-year as we continue to invest in that region.

We added 36 new clients during the second quarter. We closed the quarter with an active customer base of approximately 270 clients. During the quarter we added five accounts which we considered 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 77. We ended work for approximately 24 clients during the quarter, all of which were very small clients. Turning to cost. On a GAAP basis cost of revenues increased 60% for the quarter as compared to the second quarter of last year. On a non-GAAP basis, which excludes the impact of equity-based compensation, cost of revenues increased 57%. 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 2700 people during the quarter and ended the quarter with almost 27,800 technical staff. This is an net increase of over 9,800 technical staff from June 30th of last year. Gross margin was 44.1% for the quarter on a GAAP basis.

On a non-GAAP basis, which excludes the impact of equity-based compensation, gross margin in Q2 was 45.1%, a decline of 50 basis sequentially and an increase of 70 basis compared to the second quarter of last year. On a sequential basis gross margin was negatively impacted by our annual compensation adjustments and an increase in our bonus accrual well above our target levels, due to our strong performance, partially offset by the favorable movement of the Indian rupee. SG&A expenses, including depreciation, were 87.8 million on a GAAP basis up from 51.6 million in the second quarter of last year. GAAP SG&A expense in Q2 of this year included approximately $3.4 million of equity-based compensation expense in the quarter. As a percentage of revenues, GAAP SG&A was 26.1% for the quarter. Non-GAAP SG&A was 25.1% of revenue, up 70 basis points from the second quarter of last year and up 80 basis points sequentially from the first quarter of 2006, as we accelerated investments to differentiate our services and relationships in the market place.

GAAP operating income for the quarter increased 43% to $60.7 million. On a non-GAAP basis, which excludes the impact of equity-based compensation, operating income for the second quarter was 67.4 million, up 59% from last year. And our non-GAAP operating margin for the quarter was within our target range of 19 to 20% as we increased discretionary spending and absorbed our annual salary increases during the quarter. Interest income for the second quarter increased to 3.9 million compared to 2.1 million in the second quarter of last year. Interest income increased due to a higher global cash balance and an increase in short-term interest rates. We had a $1.5 million foreign exchange gain during the quarter, primarily due to the weakening of the rupee throughout the quarter. Our GAAP tax rate for the second quarter was 16.6% and the non-GAAP tax rate, which excludes equity compensation cost, was approximately 16.2%. Our GAAP tax rate for the quarter and expected rate for the full year are in line with our prior guidance.

Turning to the balance sheet. Our balance sheet remained healthy. We finished the quarter with approximately $468 million of cash and short-term investments, up over $140 million from June 30, 2005 and up over $45 million from March of this year. During the second quarter, operating activities generated approximately 51.6 million of cash. Financing activities, primarily the exercise of stock options, generated 14.8 million of cash. These amounts were partially offset by approximately 24.4 million of capital expenditures, including expenditures on our India construction program. In addition we generated approximately $3.7 million of cash due to currency translation adjustment. Our collection of trade receivables during the quarter continued not to be as strong as we would have liked. Based on our $266 million balance on June 30th, we finished the quarter with a DSO, including unbilled receivables, of 72 days, compared to 71 days for the same period last year and 69 days in Q1 of 2006. During Q2, excluding unbilled receivables, our DSO was approximately 62 days.

The quality of our receivables portfolio remains exceptionally strong. Our unbilled receivables balance is approximately 38 million at the end of the second quarter, up about 15.6 million from June 30 of 2005 and up 4.9 million from Q1 of this year. The increase in unbilled receivables resulted primarily from the timing of billing milestones and, more importantly, the volume associated with our continued revenue growth. Approximately 60% of our June 30th unbilled balance was billed in July. During the second quarter overall 25.2% of our revenue came from fixed-price contracts, down from 25.9 in the first quarter of this year and 25.4 in the second quarter of 2005. When we look at the mix by solution type during the quarter, 31% of our development revenue and 20% of our maintenance revenue came from fixed-price contracts. Turning to headcount. At the end of the second quarter our worldwide headcount, including both technical, professionals and support staff, totaled approximately 29,675. This represents a net increase of over 2900 people during the quarter and approximately 10,400 people compared to June of last year.

Approximately 50% of our Q2 hires were recent college graduates, who will enter our training program, and the remainder were lateral hires of experienced IT professionals. Based on our 2006 revenue expectations and our ongoing success in recruiting, we currently expect to exceed 36,000 employees globally by the end of 2006. And we are moving along well towards this goal with over 31,000 people in the Company today. Turnover, both voluntary and involuntary, was 15% annualized during the second quarter compared to 17% annualized in the second quarter of 2005. On-site utilization increased slightly to around 87% for the quarter. Offshore utilization, excluding recent college graduates who were in our training program during the quarter, was approximately 69%. Including trainees offshore utilization was approximately 57% for the quarter. We had approximately 2400 unbilled people in our training program at the end of the quarter. I would now like to comment on our growth expectations for Q3 and full year 2006.

As Lakshmi and Francisco mentioned earlier in this call, the investments we are making are producing results. The investments are allowing us to differentiate ourselves in the market place, both in terms of winning and growing new clients and expanding our service offerings. In addition, our client employee satisfaction levels remain at a level for which we are proud. This has resulted in stronger than expected results in Q2 and is allowing us to significantly increase our full year guidance for 2006. We are now projecting revenue for the third quarter of 2006 of at least $363 million. This represents 8% sequential growth and 54% year-over-year growth. We continue to have significant revenue visibility due to our high level of recurring revenue and long-term nature of our customer relationships. In fact, today we have customer commitments for well over 90% of our third quarter revenue guidance.

For the full year 2006, based on the strong demand environment for offshore services and our favorable experience in ramp-up rates, we now project revenue to be at least $1.37 billion, up $70 million from our most recent guidance and up $110 million from our initial guidance for 2006. This represents growth of at least 54%. As has been typical in prior quarters, we expect the majority of our growth for Q3 and full year 2006 will come from the ramp-up of the 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 19 to 20% range, before the impact of equity-based compensation, in line with our historic margin level and prior guidance. As stated on previous occasions, please note that our operating margin target is non-GAAP and excludes 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 Q3 GAAP EPS of $0.38 and non-GAAP EPS of $0.42, which excludes equity-based compensation.

This guidance includes the anticipation of a Q3 share count of approximately 151.5 million shares, a steady tax rate of 16.6% on a GAAP basis, on non-GAAP 16.3%, which is the year to date number, and an operating margin in the upper half of our guidance range, excluding equity comp. Based on current business trends we are increasing our expected GAAP EPS guidance for the full year to at least $1.45, up from our prior guidance of at least $1.37, and full year non-GAAP guidance of at least $1.62, which excludes equity compensation. This guidance also includes the anticipation of a full year share count of approximately 151 million shares. In addition, the guidance assumes a consistent tax rate with our current rate and a full year operating margin at the top-end of our 19 to 20% guidance range on a non-GAAP basis. We expect the vast majority of our Q3 and full year growth to come from existing clients, particularly the strategic deals that we have won over the past year and are successfully ramping up. With that I would now like to open up the call to questions. Operator?

[OPERATOR INSTRUCTIONS] Your first question comes from Adam Firsch of UBS.

Congratulations to you and the rest of your team on these fantastic results. Gordon, quick question for you, does your new role mean that you are going to get a new briefcase. Are you going to be carrying around the lucky beat up green one?

The beat up green briefcase has been very lucky so I intend to keep that one until the holes get too big.

Okay. Sounds good. Getting a little more serious now, the 20% increase in salary to the '07 hires, is that across the board? And does that materially cut into the cushion that exists in our operating margin above the 20% top-end bogey?

Yes, let me be very clear about that. The 20% increase relates to offers that we are putting out now for college students who will be joining us during the 2007 season. The impact of that change for 2007, holding everything else constant, would be about 50 to 60 basis points. And the reason for that, even though it is a large number of people, it's a relatively small portion of our cost base. So yes we do not see it changing our range and it's built into our planning for 2007.

Is there any kind of ripple affect then that happens with the other levels of people or do you just gave them more up front and then the raise once they finish the training program is less? Does it keep everything pretty much in line?

There will be a little bit of a ripple affect, but the ripple effect is not significant.

Okay. Second quarter posted your best sequential growth rate, I think, in your Company's history, despite being your biggest quarter, if I'm not mistaken, despite the multiple headwinds that you talked about on your prior call. Gordon, if you could talk about what drove it and what does it suggest about the second half of the year? Should we expect some what of a slowdown here?

Sure. There are a couple of things that occurred in Q2, probably the single biggest thing and you saw it in the growth in application management, for the first time in a long time, actually growing faster sequentially than application development. Part of what happened, we saw a real spike in application management work and when you have that kind of spike you have a lot of onsite knowledge transfer. So you kind of get this surge where you have a lot of people come onsite, obviously at higher billing rates, and then they go back offshore. And that's one reason why you saw very strong growth in Q2 and our guidance for Q3, obviously is very healthy at 54%, but on a sequential basis is slower than Q2 because now that some of that management work, the KT is done and we're starting to move it offshore. But let me let Frank and Lakshmi comment more strategically on what we're seeing that is driving this more general phenomenon of why we are doing so well.

It's Frank, Adam, I think overall, we have talked about this on prior calls, we're really benefiting from the investments we have made in three primary areas. The first is, and we talked about them on the call this morning. The first is just across all of our industry vertical segments the investments we have been making in domain experts in folks in the client-facing organizations are really paying off. We're able to engage with our clients more strategically, engage with them on more complex engagements, on really working with them to solve their business problems. So that driving growth, very healthy growth across all of our verticals this quarter was characterized by strong growth across, as I said earlier, both the large vertical, the historically big Cognizant verticals, and also the smaller verticals where we see increasing traction.

The second trend that we're benefiting from is the increased adoption and acceptance of offshoring in Europe. As we said, this quarter Europe grew faster than the Company average and we continue to feel optimistic about the demand in Europe and also our ability to service that demand as we continue to strengthen the team on the ground in Europe. And then finally, the increasing set of services we have been investing in, particularly things like ERP implementation, our IT infrastructures services that I touched on. These are new service lines that we have invested in considerably over the last several quarters and we're now starting to see real traction for those services in the market place. So I think all of those three things are coming together to generate some significant demand.

Final housekeeping question. Gordon, I noticed your guidance for EPS next quarter does not include the words at least. So I was wondering if you could just manage expectations and what is behind that, the margin guidance was pretty specific, but what is going on on the EPS line?

I think that's the -- similar to the language that we used last quarter. I think we used approximately.

Okay.

Historically we have never used at least when talking about the next quarter up.

Got it. Thanks, guys, and again, great job.

Thank you.

Your next question comes from Andrew Steinerman of Bear Stearns.

Hi, there congratulation. My question has to do with application development, you noticed the surge in application management. Obviously application development is still grew strong and it seems like the outlook is still very healthy. I was just wondering, when you just look at the application development side, do you see any slowdown from clients in terms of discretionary spending?

No, Andrew, I think the application development side has also been growing substantially. This is somewhat technology driven. I think we talked about the service oriented architecture. As more and more of these organizations adopt the new technology, the development at [first] increases and the discretionary spending is also something that is consistent, like as we have seen in the past quarters, because the benefit of this new technology is kind of immediate. The business impact is quite substantial. So we see a large number of our customers willing to enlist in these new technologies going forward.

Right. Even when you look at financial services clients, like I think about my own firm, stock market has stunk for a couple of months now, you haven't seen any change of client patterns even in financial services?

No, even in financial services we haven't seen any significant change from the prior quarters. The investments that have been committed for technology infrastructure upgrade, et cetera are continuing. There has been no pull back.

Thank you very much.

Thanks, Andrew.

Your next question comes from Moshe Katri of Cowen & Co.

Thanks, good morning, and congratulations for Frank. A couple of things, just to confirm, Gordon, you said the currency benefits were about 1.5 million during the quarter?

There are two parts to the currency benefit, Moshe. In non-operating income below the line there's $1.5 million gain and that comes from currency from the balance sheet translation. In addition to that, baked into our operating expenses, we also had the benefit from the rupee moved in our favor. So sort of something above the line as well a discrete item below the line.

What was the other benefit, can you quantify that.

The rupee moved by just over 2%. Every 1% movement's worth about 20 basis points in margin.

Okay, that's great. How do we offset the 50 to 60 basis points margin impact next year from the 20% increase in salaries?

As you know we have lots of levers to pull. Just like this year we pulled levers depending on what is happening with volume, what's happening with onsite offshore mix, utilization, the more general salary pool, bonus levels. So it's in the realm of things, 50, 60 basis points is not a lot of money to cover one way or the another.

So it's pretty manageable. And then during the second half should we see a re-acceleration in application development sequential revenue growth versus application management or are we going to keep on seeing this strength in application management that's been kind of unusual?

That's one we don't guide to. The reality is we'll do what is right for the customer. We are seeing healthy demand on both sides of the business. So it starts to become just very client specific in terms of what projects hit when and how quickly do they ramp-up? But to be very clear, yes, both sides of the business are very healthy.

In terms of turnover that's been in the mid-teens right now, do you think this is where it is going to be at by the end of the year? Or at this point do you think that is kind of stable at this point?

Turnover has seasonality generally Q2 and Q3 are the higher quarters, Q1 and Q4 are lower. For both Q1 and Q2 of this year we have been running lower than we ran last year. And our target is to be in the low teens on a full year basis. And that was our target coming into the year and that target has not changed.

Okay. Finally, can you talk about top one and top five clients in terms of revenue concentration and remind us where it was a year ago un-sequentially.

Sure we don't report top one. We had no clients over 10%, but the top five clients were 30% of revenue and grew roughly in line with the Company.

Okay. Great. Thanks a lot.

Your next question comes from the line of Bryan Keane of Prudential.

Hi, good morning. I guess since demand is really terrific, I guess the question becomes how fast can you hire to keep up with it? And what kind of supply constraints do you see in the upcoming future quarters?

I think, like you said, the demand is quite strong in our customer base as well as the new opportunities. The thing that we are most focused on today is fixing the supply side. We don't see much of a problem over the next four to six quarters. All our efforts currently are to sustain that level of input into the organization because one of the concerns that we have is longer-term, we are relying on the education infrastructure in India. Will that be in a position to support the increasing demand, not just from us, but from the entire industry. So there are several initiatives that we have undertaken in order to collaborate with the education institutions to have the right quality of people come on board. And two, there is also a question of a higher level of investment within Cognizant as part of the Cognizant Academy to train and double up people, both at the technical level but, more importantly, at the managerial and the leadership level.

I think last the quarter we talked about the management development program and the [high-fi] leadership development program, which is coming along well. And we have launched several initiatives at the mid-level to create a greater bandwidth and a greater pool of project managers and technical development experts, who can really come and deliver growth in this organization. And this, frankly, this is one of the reasons why I'm taking on a different type of a role, clearly to work with the education institutions, the academics, and also build a brand for Cognizant so that we are in a position to continue to attract large number of people from business schools, from education institutions. And also set up some institutional infrastructure to sustain the supply of qualified people on a long-term basis.

These extra investments you are talking about, especially in training, does that change the profile of the Company, the long-term pro forma operating margins of 19 to 20?

That does not change the long-term fact of the operating margins that we continue to remain in the 19 to 20% range. The enlistments that we make are some that are done at the education institutions level, we just help them do those, make some of those changes so that the people coming out of colleges are industry ready. And there are some that we have to do in our academy and a lot of it is driven by technology. I talked about the learning mechanisms, the E-learning, et cetera, so these are all wider investments, these are not substantial in terms of dollar terms but they apply technology to get to the level that we require.

Just two follow-ups.

Bryan, I'm sorry to interrupt. We only have ten minutes because I know people out there who will drop off for another call, so let me just let some other folk asks a question, if that's okay, and we can catch up with other questions offline.

Okay, great. Thanks, congratulations.

Thanks, Bryan.

Thank you.

Your next question comes from Julio Quinteros of Goldman Sachs.

Hi, guys. I have one question in 10 parts. Sorry about that. My question is actually pretty simple, too. As it relates to the 10% bump on campuses, that the info just discussed, and the 20% that you guys are talking about. Can you just explain to me what those variances are and whether you guys have sort of caught up with them or what the delta would be there in terms of the campus salaries? And related to that just the issue with regards to the turnover. It looks like it was 11% Q1 and 15% this quarter. But that's an annualized number, correct?

Let me just hit the second question and then Lakshmi will take the first one. Turnover is 11% annualized in Q1, 15% annualized in Q2, both of those quarters were lower than they were in the same quarters last year. So we're actually a couple of points better than we were last year in each quarter.

And coming back to the question on campus salaries. As you know the top three or four companies have the best luck as far as recruitment is concerned. We stated that in the majority of the campuses that we went to this year we were either number one or number two. So we had access to the best people there. And that's because the top companies offer compensation within a narrow band. And this band has moved by about 10 to 20% over the last two years. Some companies, particularly the tier two companies who went to the campuses later, had to offer greater salary in order to attract people from these universities last year. And now the tier one companies are having to do it effective next year. To that extent the band remains within the 10 to 20% range. We had to increase it a little more than the other companies because we were at the middle or slightly lower than the middle range of the band. Now we're in the upper half of the band.

And then I'll just go back to Gordon. The turnover, can you just sort of breakup that turnover number a little bit between sort of entry level, mid-management and senior management, where are you seeing the turnover?

Really no change in that, Julio It's always been at the lower levels. It's quite rare that we lose people at the senior levels unless it's more of a mutual decision. So it's at the lower levels, primarily in India. You'll see a little bit more in the U.S. as we're doing more U.S. hiring of technical staff. But no change in the general characteristics of where it's coming from.

Okay, great. Thanks.

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

Just a quick question on bill rates. Considering it sounds like you had lot of onsite work, especially in the app management, anything different going on with bill rates either offshore or onsite?

Sure. The two discrete pieces, onsite and offshore, were quite constant sequentially. On a blended basis it moved up a little bit, obviously, because we moved a little bit more onsite and you have a couple underlying things going on there. Deals are getting bigger. Obviously, larger customers get more favorable rates. We're doing a mix of business, everything from very high end work to, obviously, BPO rates are obviously at lower rates. But it's a very stable rate environment. We're not seeing anything that's causing concern.

Thank you.

Your next question comes from Sandra Notardonato of Robert W. Baird.

Hi, thanks. First question is should we be expecting any other changes to follow the executive management's announcement that you made today, such as the sales force reorganization or other things to help support the next growth phase? And then secondly, if I could get the growth of the customers that would represent your top six through 10. You gave us the first five. If I could get the six through 10, that would be great.

Yes. Let me just talk about the organization change in the succession plan. Clearly as we continue to grow, we need to increase the management bandwidth. The set of promotions and the changes that we announced today are preparing Cognizant to meet the demands of rapid growth and to be a multi billion dollar company. Surely to be followed by additional changes in the organization in terms of people from within taking greater responsibility, as well as inducting more people and more at the senior and the middle levels in the organization. This is something that we have been doing in the last couple of years. We have inducted at least a couple of very senior people into the organization, who have been well inducted into the organization, deciding responsibilities that are consistent with the overall goals and strategic mission of the Company. So we would anticipate some more changes at the middle and the senior management levels in the organization. That would be driven largely by the executive team, the five members that we announced, that people got the announcement today, they will drive the next level of changes in the organization to prepare for growth.

And Sandy, just to answer your second question. For the top 10, I don't have six through 10, but for the top 10 in total, we were a little over 41% of revenue. And the top 10 grew pretty much in line with Company average sequentially, just a touch below it.

Okay. Thank you.

Your next question comes from Edward Caso of Wachovia.

Great, thanks. Gordon, can you give us an update on your BPO business as a percent of revenue? What the outlook is. Are you still getting traction there? It wasn't mentioned today.

Ed, as you know, we don't break out the service offerings by percentage of revenue, but clearly we're gaining traction there and we're actually feeling quite good about it. Let me let Francisco and Lakshmi comment, give some more color around that.

Yes, just in terms of the BPO business, as I think we have always said and talked about on this call, our strategy with the BPO business has always been to focus on BPO opportunities that fit two characteristics. One is that have a high degree of industry knowledge within the process so that we can leverage the investments that we're making in industry-experienced folks and building domain expertise through our industry verticals. And the other characteristic we look for are business processes that have a high degree of IT content, so we can leverage our core competency in IT and systems. And what we're finding, and we have found in the last few quarters, is that that segment of the BPO market is beginning to see increased traction in India.

It took time for customers to get comfortable with moving those types of processes into a global environment and we're starting to see that happen. Over the last two or three quarters, we have actually started several pilots across many of our industry verticals, from big verticals like healthcare and financial services, to smaller verticals like media, in the BPO space, all of them focused on these higher value, knowledge intensive and IT intensive BPO processes.

Ed, be sure to remember that for BPO it will impact headcount well before it materially impacts revenue because BPO is so heavily offshore and billing rates tend to be lower than for IT. It takes a lot of people to move the needle in a material way on revenue.

Thank you.

Your next question comes from Rod Bourgeois of Bernstein.

Hi, guys. Can you give an update on where you are sourcing you growth headcount additions from? In other words, how much of your headcount additions is coming from campuses versus lateral hires or other sources?

Typically we have between 65% to 70% of our people coming from campuses and the remaining 30% to 35% at the lateral level.

And the lateral level is predominately the highest that we make outside of India. On average, for example, we hire anywhere between 30 to 35 people per week here in the U.S. , which is a substantial number. Likewise, we hire a fair number of lateral hires in India too. Reference is the single biggest source. People within the Company who like the culture, who understand the culture and the direction of the Company, and refer to us their colleagues who come in and join.

I guess my question is as your headcount addition requirement goes up, are you seeing any shift towards more lateral hiring or more campus hires?

Over the last two years it has remained consistently in that band, 60% to 70% of campus hires and the remaining laterals. We expect that trend to continue.

Rod, what that translates into is we're putting out a lot of offers right now for people to join us in 2007, because there is basically a year lead time on the college hires. And if revenue is really strong it means we have to go out into the open market a little bit, so that can move what the final mix is between college and lateral. But as Lakshmi said, we try to target that 65% range or so. Obviously year-to-date we're running about 50%, part of that is seasonality, Q3 is a huge quarter for the college kids coming in. Where exactly we end up for the year will depend on where final headcount ends up.

Great. Thanks for that.

With that it's 10:00. I know many of you have to jump for another earnings call, so -- what do we have Lakshmi, a closing comment?

Yes. Let me conclude with these concluding remarks and let me thank you once again for joining our call today. We're pleased with our financial performance during the second quarter, both the crossover verticals and our service offerings. We are confident that we have the right strategy in place to continue delivering strong financial and operating performance throughout the remainder of 2006. And we believe, more importantly, that the expanded executive management team, we announced today, formally positions Cognizant to continue our growth well into the future. And we all look forward to talking to you in the next quarter. Thank you very much.

Thank you, ladies and gentlemen. This concludes Cognizant Technology Solutions second quarter 2006 earnings conference call. You may now disconnect.