高知特 (CTSH) 2007 Q3 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 third quarter 2007 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session.

(OPERATOR INSTRUCTIONS)

I would now like to turn today's call to Scot Hoffman from Financial Dynamics. Please go ahead, sir.

Thank you, operator, and good morning, everyone. By now, you should have received a copy of the company's third quarter 2007 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. The speakers we have on the call today are Francisco D'Souza, President and Chief Executive Officer, and Gordon Coburn, Chief Financial and Operating Officer of Cognizant Technology Solutions.

Before we begin, I would like to remind you that some of the comments made on today's call and some of the responses to your questions may contain forward-looking statements. These statements are subject to the risks and uncertainties as described in the company's earnings release and other filings with the SEC. I would now like to turn the call over to Francisco D'Souza. Please go ahead, Francisco.

Thank you, Scot, and good morning, everyone. Thank you all for joining us today for Cognizant's third quarter 2007 earnings call. This morning, I will provide an overview of our third quarter results and discuss the key drivers of our financial and operating performance. I will also discuss our recent announcement regarding our intention to acquire marketRx. Finally I will provide you with some color around client 2008 spending expectations based on client feedback from our recently concluded customer conference. I'm joined on our call today by our Chief Financial and Operating Officer, Gordon Coburn, who will take you through our financial and operating results in greater detail in a few moments.

We had a strong third quarter which featured healthy continued growth across our vertical industries segments, service offerings, and geographies. Our third quarter reflects the result of several key company-wide strategic initiatives, which we laid out at the start of the year. First, we are making the necessary investments to build truly distinctive capabilities in each of the markets that we serve. Second, we continue to globalize both on the supply and on the demand sides of our business. Third, we are committed to maintaining an environment at Cognizant where the best talent in the world can thrive. And finally, we are focused on building the infrastructure processes and the intellectual capital to allow us to continue to scale the business.

The strongest drivers of our growth in the quarter were fueled by investments we have made recently to capture opportunities for future growth. Our third quarter performance also speaks to our track record of operational excellence. Our strong bottom-line results during the quarter once again demonstrated our ability to quickly pull operating levers to offset macroeconomic pressures on our cost structure and maintain our operating margin targets.

Looking at our third quarter results in detail, we once again exceeded expectations, generating $558.8 million in revenue, which represents an 8% sequential increase from the second quarter and increase of 48% from the third quarter of 2006. GAAP EPS was $0.32 for the quarter, compared to $0.27 last quarter and $0.20 for the year-ago quarter. These results are adjusted for the two-for-one stock split that we completed in October. Our GAAP operating margin was 18.1%, and our non-GAAP operating margin which excludes stock-based compensation expense was 19.7%, at the upper end of our target range of 19 to 20%.

Towards the end of the third quarter, Cognizant's Board of Directors declared a two-for-one stock split on our capital stock in the form of a stock dividend. In addition, the Cognizant Board of Directors authorized a share repurchase program of up to $100 million of the company's common stock over the next 12 months. This stock split recapitalization and share repurchase program underscored the board's confidence in the fundamentals of our business and the company's future prospects.

Now I would like to discuss the drivers of our revenue growth. One of the most important growth drivers continues to be the deep industry sector expertise that distinguishes us from the competition. We continue to benefit from our investments in cultivating this expertise across an expanding range of industries, including life sciences, retail manufacturing and logistics, and financial services. During the quarter, the number of accounts that we consider to be strategic, which means that they have the potential to generate between $5 million and $40 million or more in annual revenue for Cognizant over the long term, increased by five, bringing our total number of strategic clients to 102. As we have said in the past, we believe that the majority of our strategic accounts still have considerable growth potential, and we expect these relationships will expand further as the needs of our customers evolve and as we continue to expand our range of solution offerings.

Growth in our health care business segment was driven by the strong momentum of our life sciences practice, where we continue to expand wallet share amongst the world's top global pharmaceutical and biotechnology companies. Revenue from life sciences customers increased 16% sequentially, and 61% year-over-year. The accelerated growth in our life sciences practice came as a result of clients broadening their relationships with Cognizant to cover our full spectrum of service offerings in IT infrastructure services, BPO, and consulting. In addition, we are also starting to see a trend of increased adoption of the global delivery model by customers in the medical devices area. Our core knowledge of health care, life sciences and biotech is very applicable to the medical devices segment and gives us an advantage in that market.

Today, we count amongst our customers most of the top 20 pharmaceutical companies and many of the top ten biotech and medical devices companies. Our recently announced intention to acquire marketRx will, among other dimensions, strengthen our presence in the life sciences industry. I will speak about marketRx in more detail in a few moments.

Our retail manufacturing and logistics practice also continues to perform well, with 12% sequential revenue growth during the quarter, 56% growth year-over-year. The retail sector in particular continues to show significant potential, as retailers continue to invest in systems and applications to be more competitive in the marketplace. Large retailers are looking to Cognizant to leverage the cost advantage and the broad capabilities that we bring to the table, both in the package and custom application areas. To address the increased demand, we have strengthened our retail consulting capabilities and built key partnerships with retail software product vendors.

Finally, I want to highlight the healthy growth we continue to see in financial services despite market concerns [related to] the subprime mortgage market. Revenue from financial services (inaudible) increased 7% sequentially and 43% year-over-year. Over the last several years, we have established a financial services market leadership position, and we continue to win business across our well-diversified client base because of the depth and breadth of domain expertise that we bring to the world's top banking financial services and insurance companies. While our financial services clients continue to manage through subprime-related issues, the impact on their spending with Cognizant to date has been insignificant. We will continue to monitor the situation in BFS in light of the situation emanating from the subprime mortgage market.

Another prominent driver of our third quarter performance was the strong return on our investments to expand and globalize the company, which was another key theme for the company in 2007. European revenues increased 24% sequentially and 92% year-over-year, compared to the third quarter of 2006. Our European clients now contribute approximately 17% of total company revenue, compared to about 13% in the same quarter of 2006. The significant increase in percent of revenues from Europe is a significant accomplishment for the company given our goal of globalization. Over the past several quarters, we have been expanding our geographic footprint in Europe, as European companies have continued to aggressively adopt offshore strategies. More recently, we have focused our investments in Europe on building out service-offering capabilities in areas such as BPO, ERP, testing, infrastructure management, and CRM. These investments are showing results.

For example, in the U.K., we have seen significant growth in testing services, especially in the BFS segment. To give you an illustration, over the past three months, we have built a testing team of approximately 120 consultants for a leading financial services institution in the United Kingdom. Similarly, we are seeing demand in Europe for our advanced solutions practice, BPO, IT infrastructure services, ERP and CRM service lines. As a consequence, we are making necessary investments to take advantage of this increased demand by building management and delivery teams for each of these service lines in Europe, both on the continent and also in the U.K.

The strong growth of our horizontal services was not limited only to Europe during the quarter. We saw strong growth during the quarter across our portfolio of horizontal services. Infrastructure management, testing, ERP, and CRM all grew well in excess of the company average. Data warehousing and business intelligence grew 77% year-over-year or 16% sequentially, and represents another strong example of our endeavor to establish distinctive capability in each of our service lines. Our standing as a distinctive data warehousing and business intelligence service provider was further validated when we were recently awarded the "Best of the Best" Award from Computerworld Magazine at their 2007 Best Practices in Business Intelligence Conference. Cognizant was recognized in the Innovation and Promise in Business Intelligence category for the work we did in the area of business intelligence as a service for one of our key clients. This is the third consecutive year in which Computerworld has recognized Cognizant for our expertise in data warehousing and business intelligence.

Consistent with our acquisition strategy, we also recently announced our intention to strengthen our global life sciences BPO and analytics offering with the acquisition of marketRx for $135 million in cash, which we expect to close during the fourth quarter. MarketRx is one of the largest and fastest-growing independent offshore analytics businesses, providing services to global companies in the pharmaceutical, biotechnology, and medical devices market segments. MarketRx has a unique delivery model comprised of high-end knowledge process outsourcing services delivered through an innovative software-based platform. MarketRx is a high-growth business that we expect will enable Cognizant to simultaneously accomplish several of the strategic objectives which I laid out earlier.

First, it will extend our position in providing value added outsourcing services to life sciences, biotechnology, and medical devices companies. MarketRx expands our domain capabilities and broadens our service offerings to address all areas of the life sciences value chain--from research and development and manufacturing, to sales and marketing operations. MarketRx will bring an impressive client base to Cognizant representing a total of 75 life sciences customers, including all of the largest 20 pharmaceutical companies and four out of the top five biotech companies.

Secondly, we believe that there is significant potential to cross-sell marketRx's analytics service offerings to clients in our other industry verticals, building on the success of our vertical BPO strategy. And finally the addition of marketRx's expertise represents a growth opportunity for Cognizant's core technology services since we expect to see synergies with our existing business intelligence and data warehousing and CRM services.

Before I comment on our outlook for the business going into 2008, it's important to note that we achieved strong performance in the third quarter while continuing to execute on the process we outlined in the first quarter to address the macroeconomic challenges facing our industry. Specifically, we followed through on our plan to increase utilization in order to offset rupee appreciation, wage hikes, and taxes over the course of the year. We delivered approximately 30 basis points of sequential margin expansion, and our earnings results exceeded expectations.

As we further extend our track record of effectively managing our business while investing to further differentiate Cognizant in the eyes of our customers. To accommodate our expectations for future growth, we added a net of 3,300 employees during the quarter, bringing our total employee base to approximately 49,000 worldwide at the end of September. We also recently crossed an important milestone when we hired our 50,000th Cognizant associate. We are on track to end the year with our previously stated goal of approximately 55,000 employees around the world, which underscores our commitment to investing in our people and infrastructure ahead of demand.

Employee attrition decreased slightly from the second quarter to 16.7%, which represents a significant 370-basis point decline from the year-ago quarter. We are comfortable with the progress that we have made in reducing our attrition rates through an innovative combination of engagement initiatives with our associates as we outlined on previous earnings calls. As I said earlier, we remain committed to maintaining a environment at Cognizant where the best talents in the world can thrive.

During the quarter, we also continued to make progress on our previously announced infrastructure expansion program across India. In addition, once completed, our acquisition of marketRx will enable us to expand Cognizant's global delivery platform into northern India, where marketRx has based its delivery operations in the New Delhi (inaudible) region.

Moving forward, we are confident that our rigorous [customer-centric] focus will continue to drive demand for our services over the long term. An example of our commitment to collaborating with our clients is our customer conference Cognizant Community. Last week, we concluded our eighth annual event in North America and the largest to date.

The conference is significant for two reasons. First, attendance at this year's community exceeded 300, with Cognizant customers representing 149 companies from every vertical industry we serve. The event enables us to strengthen our relationships with our clients and engage in substantive discussions about the common issues, challenges and opportunities that they face in their businesses, and the role that outsourcing plays in helping them achieve their business objectives and ultimately strengthen their companies.

Secondly and of equal importance, Cognizant Community enables us to gain qualitative and quantitative insights into our customers' initial IT spending plans for the year ahead. As part of Community, we conducted a formal survey to assess our clients' budget plans and spending priorities for 2008. More than 150 Community attendees--CIOs, [CEOs], VPs of IT, and other senior decision makers--responded to the survey, representing a broad cross section of Cognizant clients in banking, financial services, insurance, health care, life sciences, retail, manufacturing, and the telecommunications vertical.

The survey yielded several illuminating data points. First, despite the uncertainly in the market about the economic outlook for 2008, 92% of our clients do not expect their overall IT budgets to decline going into 2008. Second, we asked respondents to provide us with a view of the likely impact to their offshoring budgets in the event of a decline in overall IT budgets. Only 19% of the respondents said that an overall IT budget reduction would meaningfully impact their offshore spending plans in 2008. Thirdly, outsourcing budget growth is expected to outpace overall IT budget growth in 2008, with 90% of respondents citing continued growth in offshore development spending. And finally, amongst the financial services customers that completed the survey, about 90% do not expect their IT outsourcing budgets to decline in 2008. On the whole, the survey gives us further confidence in the growth prospects for Cognizant in 2008.

Now, I will turn the call over to Gordon to walk you through our financial and operating results in greater detail. Gordon?

Thank you, Francisco, and good morning to everyone. I would like to provide some additional information on the third quarter, and then discuss our financial expectations for the remainder of the year.

Revenue for the third quarter exceeded our prior guidance and expectations due to continued strength in Europe, strong year-over-year growth in our retail manufacturing and logistics segment, as well as health care, and all three of our industry verticals within our other business segment. Quarterly revenue grew 8% sequentially and 48% year-over-year. As the quarter proceeded, we continued to see healthy volume growth across the 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 almost $79 million year-over-year, and represented 47% of revenue for the quarter. Health care grew $43 million and represented 23% of revenues. Retail manufacturing logistics grew by over $31 million, representing approximately 15% of revenues for the quarter. The remaining 15% of our revenues came primarily from other service-oriented industries of telecom, media and technology, which grew by almost $29 million compared to the third quarter of last year.

During the quarter, financial services grew 43% year-over-year, and 7% sequentially. Health care grew 49% year-over-year, and 10% sequentially. Retail manufacturing logistics grew 56% year-over-year, and 12% sequentially. Growth in our retail manufacturing logistics segment was driven by several newer retail clients which we have won and are now ramping up. And our other business segment grew 54% year-over-year, and 5% sequentially. Growth on the other segment benefited from strong growth in our information and media operation, as well as technology and communications.

For the quarter, we saw healthy demand for our entire service offering. Application management represented 51% of revenues, and application development was 49%. Both services continued to grow significantly in Q3. Application management grew 45% year-over-year, and 6% sequentially. And application development grew 52% year-over-year, and 11% sequentially due to strong discretionary spending during the quarter.

During the quarter 82% of revenues came from clients in North America. Europe was approximately 17% of total revenue. The remaining 1% of revenue came from the Asian market. As Francisco mentioned, our European business grew 24% sequentially, and 92% year-over-year as we continue to invest in that region.

We added approximately 55 new customers during the third quarter. We closed the quarter with active customer base of 445. During the quarter, the number of strategic accounts, which we consider to have the potential to ramp up to at least $5 million or as high as--more than $50 million in annual revenue, increased by five, bringing the total number of strategic clients to 102.

Turning to costs, on a GAAP basis, cost to revenues exclusive of depreciation and amortization increased 52% for the quarter, as compared to the third quarter of 2006. Third quarter cost to revenues included approximately $4.3 million of equity-based compensation expense. The increase in cost [of] revenues was due to additional technical staff, both [on-site] and offshore, required to support our revenue growth, as well as the impact of the [strength in] rupee and wage increases that were affected in the second quarter of this year.

We increased our technical staff by 3,100 during the quarter and ended the quarter with approximately 45,800 technical staff. This is a net increase of close to 13,600 technical staff from September 30, 2006.

Third quarter SG&A including depreciation and amortization expenses was $140.4 million on a GAAP basis, up from $100.3 million in the third quarter of 2006. GAAP SG&A expense in Q3 of 2007 included approximately $4.8 million of equity-based compensation expense. As percentage of revenue, SG&A including depreciation and amortization expenses was down as we continue to leverage our [scale] efficiencies.

GAAP operating income for the quarter increased 47% to $101.1 million, from $68.8 million in the third quarter of 2006. On a non-GAAP basis, which includes the impact of $9.2 million of equity-based compensation expense, operating income for the third quarter was $110.3 million, up almost 45% from last year. Our GAAP operating margin was 18.1% for the quarter, and our non-GAAP operating margin for the quarter was 19.7%, in-line with our target range of 19% to 20%. During the quarter, operating income continued to be impacted by appreciation of the Indian rupee. The average rate for the rupee was approximately 40.4 in the third quarter versus 41.1 in the second quarter of 2007.

Interest income for the third quarter increased to $7.9 million, compared to $4.8 million in the third quarter of 2006. Interest income increased due to higher global cash and short-term investment balances, as well as an increase in short-term interest rates. We had a $2.6 million foreign-exchange gain during the quarter. Our GAAP tax rate for the third quarter was 13.9%. During the quarter, we had a favorable settlement of certain tax uncertainties. In accordance with FIN 48, the results of this settlement were required to be recognized as a discreet item during the quarter. Assuming no further discreet items for the remainder of the year, we expect our fourth quarter tax rate to be 16.4%, and our full-year tax rate to be approximately 15.6%.

Turning to the balance sheet, our balance sheet remains very healthy. We finished the quarter with over $809 million of cash and short-term investments, up over $273 million from September 30, 2006, and $99 million from June of this year. During the quarter, operating activities generated over $129 million of cash. Finance activities, primarily the exercise of stock options and related tax benefits, generated approximately $18 million of cash. These amounts were partially offset by almost $40 million in capital expenditures, with the final earn-out payments of approximately $12 million related to our 2005 acquisition of Fathom Solutions. In addition, we generated approximately $2 million of cash due to currency translation adjustments.

For 2007, we continue to expect to spend up to $180 million in capital expenditures, a substantial majority of which is related to the construction program and equipping of additional development facilities to support our growth as we had previously announced. Our collection of trade receivables improved slightly from the third quarter of 2006. Based on our $428.5 million balance in September 30, we finished the quarter with a DSO including unbilled receivables of 71 days, compared to 72 days for the same period last year. During the third quarter, excluding unbilled receivables, our DSO was approximately 61 days.

The quality of our receivables portfolio remains very strong. Our unbilled receivables balance was approximately $56.4 million at the end of the fourth quarter, up almost $14 million or 32% from September 30, 2006, and up less than $2 million from Q2 of this year. Approximately 56% of our September 30 unbilled balance was billed in October. During the third quarter, overall 24% of our revenue came from fixed-price contracts, consistent with both the second quarter of this year and the third quarter 2006. When we look at the mix-by-solution type during the third quarter, 30% of our development revenue and 18% of our maintenance revenue came from fixed-price contracts during the quarter.

Turning to head count, at the end of the third quarter our worldwide head count, including both technical, professional, and support staff, totaled approximately 48,900. This represents a net increase of 3,300 people during the quarter and 14,500 since September 30, 2006. Approximately 70% of our Q3 hires were recent college graduates who will enter our training program, and the remainder were lateral hires of experienced IT professionals. During the fourth quarter, we expect to add a significant number of new employees including many recent college graduates who will be entering our training program.

Turnover, including both voluntary and involuntary, was slightly below 17% annualized during the third quarter. Third quarter attrition was over 300 basis points lower than our attrition in the third quarter of 2006. As discussed previously, we had to launch the global initiative to ensure that our employees receive appropriate rewards, recognition. and personal and professional growth opportunities across their entire life cycle with Cognizant, and we believe this reduced attrition is a result of those efforts.

As we discussed in the second quarter, as part of our strategy to offset the impact of the appreciation of the Indian rupee, we are increasing the company's utilization levels. Due to scaled economies and historically heavy overinvestment in bench resources, we were able to successfully further increase our utilization rates during the third quarter. On-site utilization increased slightly to around 87% for the quarter. Offshore utilization, excluding recent college graduates who are in our training program during the quarter, was approximately 68%. Including trainees, offshore utilization was approximately 58% for the quarter. We have close to 5,000 unbilled people in our training program at the end of the quarter, which positions us well from a staffing perspective as we enter 2008.

And now, I would like to comment on our growth expectations for the remainder of the year. The investments we are making are producing results. They are allowing us to differentiate ourselves from the marketplace, both in terms of winning and growing clients [to expand] our service offerings. For the fourth quarter of 2007, we are projecting revenue of $590 million to $595 million. As Francisco mentioned earlier, we are seeing very positive comments from our clients regarding the planned 2008 spend on offshore outsourcing.

However, we are not seeing a year-end budget flush as we experienced in the prior few years. We continue to have significant revenue visibility due to our high-level recurring revenue and long-term nature of our customer relationships. In fact, today we have customer commitments for foreign excess of 90% of our fourth quarter revenue guidance. For the full year of 2007, based on strong demand environment for offshore services and favorable experience on ramp-up rates, we are pleased to increase our guidance to between $2.125 billion and $2.13 billion, a $15 million-plus increase from our prior guidance given in early August. This revised guidance represents a growth of approximately 49% and an increase of over $700 million in revenue compared to 2006.

As has been typical in past years, we expect the majority of our growth for the remainder of 2007 will come from the ramp-up of clients we have won over the past few years. Assuming no further material appreciation of the rupee. our guidance assumes that we will continue to be in the upper half of our targeted 19% to 20% non-GAAP before the impact of equity-based compensation range for the fourth quarter. With this expected level of revenue growth and our expected operating margins, we are currently comfortable with our ability to deliver in the fourth quarter GAAP EPS of $0.31 and non-GAAP EPS of $0.34, excluding equity compensation expense of approximately $0.03. This guidance includes the anticipation of a Q4 share count of approximately $307 million shares, a tax rate of 16.4%, and an operating margin in the upper half of our historic guidance range of 19% to 20% excluding the cost of equity compensation.

For the full year 2007, based on current business trends, we currently project GAAP EPS to be $1.14, and full-year non-GAAP EPS to be $1.24 excluding equity compensation expense [at] approximately $0.10. This guidance includes anticipation of a full-year tax rate of 15.6%, a share count of approximately 304.7 million shares, and an operating margin in the upper half of our guidance range.

Please note that our GAAP EPS guidance for the fourth quarter and full year assume no P&L impact from the recently enacted fringe benefit tax from the exercise of stock options in India. The accounting treatment for this new tax is yet to be finalized by the accounting industry.

In conclusion, we are pleased with our strong growth in Q3 and are quite optimistic about our market position for the future. We believe that we understand the margin-related issues currently facing the industry, and that we have taken appropriate short-term to long-term actions to manage these issues while continuing to invest in long-term growth. Now, we would like to open the call for questions. Operator?

(OPERATOR INSTRUCTIONS)

Your first question comes from Adam Frisch with UBS.

Thanks. Good morning, guys. In reading the release, both of you went out of your way to speak very positively and favorably about the '08 growth outlook, which I found comforting. But wondering how we should to connect the dots between the slowdown we've seen through '07, especially what we are seeing in--I know the year-over-year comps are tough in the fourth quarter, but 3Q came in a little bit light as your stock is reflecting this morning. So how do we connect the dots here in terms of the slowdown that we are seeing in '07? Does that continue into '08 or [whether] certain actions in the second half of the year which don't necessarily make them the right points to extrapolate next year's growth trends on?

Adam, it's Francisco. I think you have to look at a couple of things. When you look at the third quarter, the growth across our segments was quite healthy, as Gordon mentioned. Health care grew 10% sequentially. Retail manufacturing and logistics grew 12% sequentially. Europe was very strong at 24% sequentially. Financial services grew 7% sequentially. Now, it's interesting if you parse out financial services a little bit, between financial services and insurance, what happened in the third quarter in financial services or our DSSI-segment, if you will, is that the financial services piece actually grew considerably faster than 7%, and insurance actually grew a little slower than 7%. So, we actually saw strength in the, if you will, core financial services sector, as well. So, overall the--if you look at the pieces of the business, they are all growing quite well in the third quarter.

As you look out to the fourth quarter as Gordon said, what's really going on there is that unlike in prior years, we are just not seeing the budget flush that we saw in prior fourth quarters. Gordon?

Yes, I think Francisco hit the key thing. If you look historically, some fourth quarters we saw very high sequential growth. Other fourth quarters is a little bit weaker due to customers not pulling projects or launching projects early. Clearly this year, we are not seeing that budget flush. But we also think that actually it sets us up fairly well on a sequential basis for next year. And in our mind, the most important thing is what we are hearing from our clients--that at this point, despite some of the economic headwinds, clients are saying they want to keep increasing outsourcing in 2008. And the big question, if you go back six, eight, ten weeks ago, was what did all of this credit crunch mean for the 2008 budget. And what we are hearing so far, now that we have some quantitative data from our clients, is that some of the economic issues may turn out to be a positive factor for us.

Okay. Hitting the trim line topic, I appreciate your color there, but.I think the critical point here is that right now is the trim line that we are seeing, especially in the fourth quarter of growth, the top end being around 40%, maybe a little bit slower, is that the kind of growth we should expect going forward? Or can we actually see a rebound and somewhat of an acceleration as we head out of fourth quarter?

Obviously the year-over-year comparable for the quarters is tough in the fourth quarter. We are not ready to give guidance for 2008 as we have done always in the past. We want to finish the planning cycle with our clients, so when we put out numbers we have a great deal of confidence in them. So, little too early to know exactly what the numbers will be for 2008. But certainly qualitatively, we are hearing quite positive things from our clients.

Okay. And then (inaudible) slowed sequentially, but development actually accelerated. So that's also like it's a positive sign in terms of what your clients are thinking. Not what you would normally expect [given] some of the negative expectations out there on macrospending--

That was a pleasant surprise.

Right.

In Q3, the discretionary spending was strong despite some of the macroeconomic activities. And what I've said is clients still want to get work done, and to get it done by removing it offshore.

Okay. Were there any company or more likely customer-specific issues in the quarter here, where maybe a ramp-up didn't happen as fast, or someone decreased spending where that impacted the overall rate?

You [always] have a little concern there, but nothing--

Nothing material.

That stands out.

Okay. And then last question on the factors driving down the SG&A expense as percent of revs--are these kind of things sustainable, and should we expect this to continue in the future? Was it part of the utilization increase, or was it a kind of a one time thing in the third quarter?

No, I do not view that as one time. Clearly, there are scale efficiencies and SG&A. Our goal is to continue to stay in that--excluding option expense--in the 19% to 20% margin range. And we still have leverage we can pull if needed. But as we demonstrated in the third quarter, the level is going to be [pulled] checked in nicely, and we are feeling pretty good about our ability to match cost, and that's not at the top of our priorities to focus on.

Okay. Thanks, guys.

Your next question comes from Moshe Katri with Cowen and Company.

Yes, thanks. Good morning. Just to follow up very briefly on Adam's question--the budget flush comment, is that coming out from any specific vertical or verticals and maybe top ten clients? And then also kind of focusing on the budget cycle that's going on right now, we are hearing that the decisions on '08 spending budgets have been kind of pushed out from the typical--I don't know. You guys typically hear about this towards the end of November, early December. And now we are talking about January. Is that--is this something that you are hearing as well, and will that impact funding for projects in Q1 of next year? Thanks.

Moshe, let me take the first part of the question. Francisco will talk about the budgets. The question on the budget flush or lack of budget flush, [as] any one in the industry, the answer is no. It's across the board. It's clearly not something that's specific to financial services. When I look across all of our segments, it's fairly consistent.

And with respect to the budget cycle, Moshe, as I said, we've just come back from the customer conference. I didn't hear anything--although we didn't specifically ask the question during the formal part of the survey--nothing that I heard qualitatively tells me that budget cycles are getting elongated beyond the normal process. The normal process [for] clients is that you start to get some clarity in November, December, but in reality, most clients don't lock down their budgets until the middle of the first quarter--the early and middle part of the first quarter. And nothing that I heard at the customer conference suggested that is going to go longer than that.

Thanks. And then just very briefly, Gordon, can you comment on pricing during the quarter on-site versus offshore?

Really no surprises there. On-site sequentially, we were up a little bit. Offshore was flat. But that's more as BPO is ramping up. So if you just took IT, we would have been up a little bit. So, we were tracking right where we are planning. Average realized rate up about 2% for the year.

Thanks.

Your next question comes from Anthony Miller with Arete.

Yes, Anthony Miller (inaudible) here. I'm just interested in those statistics you gave from your customer forum, when you said that (inaudible) 92% do not expect overall IT budgets to decline. 19% said budget reduction would meaningfully reduce offshore plan. For the [8%] who do expect their overall IT budget to decline going into '08, what characterized them? Were they in a particular industry sector? Were there particular pressures that are unique? And similarly, for those that said that an overall IT budget reduction would reduce offshore, again could you characterize why?

Yes. I think we looked at that. It's hard to draw conclusions. The reasons are all over the place. You have a few people, for example, that might have had an unusually high investment year in 2007, and naturally budgets will go down in 2008. I can think of a client or two that has done that. And then you just have some clients who look at things and say given--if our overall IT spending were to decline, that would have a proportionate impact on our offshore spending. That tends to be the more mature clients who have moved a substantial amount of their work offshore. For the clients who are less mature with offshoring, you typically tend to find that a budget cut will incent them to move work offshore a little bit more aggressively. But when there isn't that opportunity to do that because they moved a lot of their work already offshore, then an across-the-board budget cut will have the impact of potentially reducing the spending both offshore, as well. And that sort of ties, if you will, to comments we've made earlier about our strategic customers and the number of customers that we think are mature, and that they've moved significant portions of the work that they can move offshore. That number in our case is relatively low, and that reflects in these statistics, as well.

Did you run a similar survey this time last year? And if so, how did the results compare?

No, we did not do a formal survey last year.

Okay then. All right. Thanks very much.

Thank you.

Thanks, Anthony.

Your next question comes from Brian Keane with Credit Suisse.

Hi, good morning. I'm just trying to understand--you are not seeing a budget flush at the end of this year but you feel confident about 2008.. Why wouldn't you be nervous about 2008 as the budget flush isn't coming this year?

I think it's really based on what our clients are telling us. They are saying that this year they don't have the extra money in their 2008--sorry, in their 2007 budget, but as they're planning and starting to lock down their budgets or get further into the budget process for 2008, that their part of the way they are making the budgets work next year is to further leverage offshoring. Now in prior years, sometimes you would see people start the development project this year instead of wait till January 1 or start to finish one up earlier because people just had more dollars left over. What we were hearing this year is yes, they have stuff ready to go, but they got to wait for their new budget dollars to become available.

Okay. If you look at the revenue by geography, obviously Europe grew exponentially, but North America didn't grow quite as fast. I have it at about 5.6% sequentially, and that's slower than we have seen in the past. Was there anything in particular in North America that slowed the revenue sequentially?

There's nothing--there was no one item. Nothing specific.

Okay. And then just maybe finally, obviously we are all going to be kind of waiting for 2008 and beyond. But I don't know, Francisco, is there any kind of long-term growth rate or revenue growth rate you think the company can maintain over the next three years that we can kind of target?

What we've said in the past--what we continue to be comfortable with is that, given the investments we are making in the business, that we can continue to grow the business faster than the industry and faster than our key competitors. And I'm still comfortable with that.

Any idea how fast the industry is supposed to grow next year?

There are a lot of statistics out there. And the industry will grow probably slower than our competitors. So that is one that flushes out as we go along. When we think about our strategy of keeping our margins a little bit lower than our competitors', which we have done for years, and we've invested that back into relationship management, the customer experience, domain expertise, we feel the best measure for ourselves. And we hope the way investors think about measuring if our strategy successful is are we growing faster than our key competitors (inaudible) on a full-year basis. Obviously, we have been doing for awhile. And based on what we see, we believe that will continue.

Okay, thanks a lot.

Your next question comes from Joseph Foresi with Janney Montgomery Scott.

Hi, guys. I wonder if you could talk a little bit about the changes in methodology that we are seeing involving guidance. Typically, we see a number, and then obviously a [phrase] associated with it. Do you expect that to be--is that just sort of a quarterly change? Or is [that] a change in the thought process of giving guidance?

(inaudible) about two things. One, because we had our client event last week, (inaudible) earnings a couple of days later than normal, and therefore we have our October results in already. So we have a better sense of where we are. And had a couple of analysts who were getting fairly aggressive, so we wanted to make sure that people didn't have unrealistic expectations for Q4. So we want to set more of a boundary for this quarter. Obviously when you start a year and you have 11 months ahead of you, I would expect we will probably go back to our old language as we get into next year.

And just a second question here--It sounds like what you are seeing is less of a budget flush, but you're confident of spending towards next year. Assuming that it's not the picture that you are seeing right now, is there a way that you guys plan on maybe compensating for a potential slowdown? And if so, what are the areas of growth you would target in order to continue to keep the business moving forward?

Because of our strategy of heavily reinvesting in the business, we are already investing in multiple areas (inaudible) service line expansion, geographic expansion, domain expertise. And I think we will continue that strategy. Obviously if there is a major recession, that's going to impact everyone. But the good news is, based on what clients are saying now, it seems fairly clear to us that cutting offshore is not going to be at the top of their list.

And just really lastly, just curious as to what the impacts you are experiencing from the recent acquisition next quarter on the top line. Thanks, guys.

For the fourth quarter, we expect marketRx to close as we get further into the latter part of the quarter. So the impact on Q4 will be fairly small, and we have a small amount of revenue built in. And obviously, we get the full impact for Q1.

Thank you.

Your next question comes from Ashish Thadhani with Gilford.

Yes, good morning. Just to pick up on the last question--Do you have anything more specific for marketRx on an annualized basis in terms of revenue, recent growth and profitability?

Yes, on a full-year basis, marketRx will be $40 million-plus business in 2007. Profit margins excluding all of the purchase accounting stuff for 2008--we would expect it to be roughly in-line with company average. It's a business that's obviously growing, and we think--we bought it not for any cost synergies. They already are a very efficiently run business. What we think are some meaningful revenue synergies--that we would certainly hope to capture as we go into 2008.

Great. And one other question. There has been some talk of salary moderation attributed to Cognizant management. Could you elaborate on your expectations for next year?

Sure. Obviously we don't give our salary increases until April, and how much we give will depend largely on what other tier-one players give because we certainly will make sure that we are competitive with our tier-one players. But we certainly will not be seeking to gain any advantage there. We are hopeful that wage increases in 2008 will be less than 2007. But it's a little too early to know for sure. As we get into the first quarter, we should start to probably get a better flavor on that.

Thanks, Gordon.

Your next question comes from Ed Caso with Wachovia Capital Markets.

Good morning. Can you--any initial thoughts on the tax rate for 2008?

Hey, Ed, did you say 2008 or 2009?

2008.

2008 I would not expect any material change from the 16.4. So this year, a full year will be 15.6 because we had one-timers. But excluding the one-timers, we are at 16.4 for this year. So, yes, certainly my model for next year I'm assuming will be around 16.4 again. I'm sure It will be a little less or a little more. But that would be our best guess.

I didn't hear it if you did--your top account percentage of revenue?

Sure, hold on one second. The top five customers in the third quarter represented 24% of revenue, and the top 10 customers represented 34% of revenue.. Each of those were down 1 percentage point from the second quarter, which is a trend that's obviously been going on for a long time as size of our customer base grows.

One last (inaudible) to the H1B visa--I see there's a legislative proposal to maybe push up the feed of 5,000 per application from 1,500, and if you knew where that stood. And how important are the H1Bs, and are you changing the way you--the model works and maybe address some the tightness in the H1B market?

Certainly, our business model is enabling us to do more and more U.S.-based hiring as we get bigger. So we don't have the utilization risks. So we continue to increase our U.S. hiring. Certainly, it is important to leverage the visa programs to bring over where there's specific skill (inaudible) that we can't find here, as well as some of the knowledge of the on-site offshore model. Obviously, we'd prefer if the fees don't go up, but given the size of our corporation, I'm not sure if the fees go up a little bit, if that's going to materially change anything.

Okay. Thank you.

Your next question comes from George Price with Stifel Nicolaus.

Hi. Thanks. Thanks very much. Going back to the comments on the financial services vertical, and you noted, Frank, that insurance was actually the slower growing component as opposed to the other financial services area that people might be more concerned about. Why did insurance grow slower? Was there something--did something happen at a particularly large client? Or can you give us a little bit more color around that?

Yes, we obviously looked into that in detail. There is nothing really specifically on there. We just look at that as the ups and downs in the business. Insurance has been growing very well for us over several--over a long period of time now. And it's--the insurance segment is one where we have a very good position in the marketplace. So I wouldn't attribute that at this point to anything beyond just ups and downs in the business.

Okay. And do you guys have a--when you're talking about budgets, flattish budgets, looking into next year overall, do you have an overall view on this year? And I guess where I'm going with the question is based on what you maybe saw this year for your view, what overall budgets did this year, even if they are still going to be flattish, maybe up a little bit, they're probably going to be--the growth is probably going to be down, say, from this year, and--just trying to understand the confidence in that kind of--lose that multiplier effect with the even--given the offshore component maybe increasing within those budgets.

Just to be clear on the survey for next year, we are--92% of the client said budget's not declining. But that doesn't mean they are all flat. So, yes, we would expect that overall IT budgets are growing a little bit for next year. How much compared to this year? That's--our sense is that becomes more of a rounding error. I'm not sure they aren't dramatically different trends from what we are seeing at this point.

Okay. And, Gordon, did you say 304.7 million shares for the fourth quarter?

Hold on one second. Our guidance is based on--for the full year 304.7 for the fourth quarter. 307 million.

Okay. Thank you.

And now, Operator, we have time for one more question.

Thank you. Your final question comes from Julio Quinteros with Goldman Sachs.

Great. Gordon, just to go back and kind of try and beat a dead horse here, I guess, the 2008 outlook--maybe approaching it a little bit differently from more of a bottoms-up perspective, if we look at head count growth for 2007, right now we are looking for about 42% head count growth to finish the year at 55,000, and thinking about that into 2008 from sort of a utilization perspective or pricing perspective and the levers that normally drive this business, why would we not see kind of the normal trend that we've seen over the last two or three years where head count growth is sort of the best or one of the most important leading indicators that we have for revenue growth in 2008?

Sure. That's an important question. For a couple years, Julio, we were trying to take utilization down. We actually grew head count faster than revenue. Now we are taking utilization up a bit. As we have got scale efficiencies, we came to understand that we've stopped optimizing a little bit, running low utilization as we did. So we have come up several points this year. I would expect we will go up a little bit more next year even if the rupee doesn't move just because it's the right thing to do operationally. So I think that's driven by some of the [natural] scale efficiencies in utilization. But we'll be coming out of the year with a very healthy bench of freshers who are in the training program, then obviously we do as much lateral hiring as we need.

So if your head count growth finishes in the 42% range, utilization is going up, pricing is probably flat up to next year as well, it would seem like anything below a 40% growth rate would be a little bit conservative, or am I thinking about that incorrectly?

What can--we haven't given a guidance for next year. And it all depends on how much lateral hiring we do. But as Francisco and I said, we are certainly hearing positive things from our customers.

Okay. Let me try it from a different perspective then. On the key competitors (inaudible) emphasis on average are expected to grow about 30% next year. Some of these guys are double the size that you guys have. Does that seem like a sustainable growth rate at least for the next 12 months for the key competitors of the industry?

Let me reply. We would certainly expect to grow faster than our key competitors. And we don't see that we are about to fall off a cliff by any stretch of the imagination based on what we know today.

Okay. And just finally on the margins, the gross margin sequentially looked like it was down from where we were last quarter. Typically June is the trough. Can you give us the breakdown of what drove the gross margins from June into September on a basis-point perspective if possible?

Sure. The big piece of it is because the efficiency action primarily utilization really kicked in and we're gaining the benefit from it. We are sharing that with our employees through higher bonuses. So we took our bonus accruals up in the third quarter.

Oh, okay. Great. Thanks.

Our employees to do what they could if they could generate the benefits.

Okay. And the rupee--we know what that did. Anything else? I think you mentioned D&A, as well. Was there anything with the D&A? No, that's actually out of that line. Okay.

The rupee wasn't that. It was the rupee a little bit. Actually the rupee--yes, it was the rupee and the bonuses. Those are the two [ends].

Got it. Great. Thank you.

I would like to turn the call back over to management for closing remarks.

Well, thank you very much, everyone, for joining us on the call today. In conclusion, I would like to say we are pleased with our strong financial performance during the third quarter. Moving forward, we continue to closely manage the business model to generate long-term value for our shareholders while investing in further difference (inaudible). We are confident our focused investment strategy and our ability to capitalize on the most strategic opportunity for future growth will continue to translate into strong financial and operating results. We look forward to talking to you again next quarter. Thank you.

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