高知特 (CTSH) 2009 Q3 法說會逐字稿

Ladies and gentlemen, welcome to the Cognizant Technology Solutions third quarter 2009 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) Thank you.

I would now like to turn the conference over to David Nelson, Vice President of Investor Relations. Please go ahead, sir.

Thank you. And good morning, everyone. By now shoe have received a copy of the Company's third quarter 2009 earnings release. If you have not, a copy is available on our website, Cognizant .com. The speakers we have on today's call are Francisco D'Souza, President and Chief Executive Officer, and Gordon Coburn, Chief Financial and Operating Officer of Cognizant Technology.

Before we begin I would like to remind that you 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, Frank.

Thank you, David. And good morning, everyone. Thank you for joining us today. We are extremely pleased to report one of the strongest quarters in the history of Cognizant. We delivered $853.5 million in revenue, well above our guidance, and an increase of 16% year-over-year, and 10% over last quarter. Our revenue addition of almost $77 million over Q2 was our largest-ever absolute sequential increase in revenue.

As a key point, we have had many strong quarters in prior years in the midst of growth markets. But to deliver the largest-ever absolute sequential increase in revenue in the Company's history, in the current economic environment, is particularly gratifying. I will let Gordon cover the details of the financial and operating metrics for the quarter, in a few minutes, which was strong across the board. Today's results demonstrate not only that we are using this economic slowdown as an opportunity to build a stronger Company, but that we have extended our lead relative to others in the industry.

Of particular importance, our Q3 performance was very balanced with great consistency of results, across our industry sectors, service offering, and geographies. This consistency shows the value our clients see in the Cognizant business model and experience regardless of the market that we serve. Over the past several years, we have reinvested in our model to provide not only cost savings but increased client innovation and effectiveness on one platform. In today's economy our clients have shared with us that this model is more relevant than ever.

To put additional color around our strong results this quarter I will focus my comments this morning on four areas. First I will be discussing the Q3 industry level demand environment and our resulting overperformance. However, this is only one part of the story, since our strong results are contrasted with the rest of the industry are the result of more than industry level demand dynamics. The second topic I will discuss today is Cognizant's unique value proposition to the market and some key take-away points from our Q3 results in that respect. Third, since our value proposition is closely tied with our strategy of reinvestment, I will quickly touch on some of the key investments and two acquisitions that we announced in recent months. And finally, I will provide some commentary about our outlook for the rest of the year.

Let's start with a look at the Q3 demand picture. As we told you during last quarter's call, we entered Q3 with a strong pipeline across our full range of service offerings but we remained cautious with regard to how quickly these projects would close and convert to revenue. What surprised us this quarter was the speed at which decisions were made. As it turns out, the relative stability, if not recovery, of our clients' businesses, helped accelerate the signoff and launch of a number of projects. As the pace of decision making accelerated during the quarter, our strong client facing teams were ready to react and capitalize on the opportunities. At the height of the recession, these teams defended our position and revenues with clients. These same teams are now playing offense as the demand environment has stabilized.

While we benefited this quarter from increased demand and faster decision making, our strong results when contrasted with the rest of the industry are the result of our solid differentiated value proposition in the marketplace. We are deeply committed to giving our customers the best experience in the industry. To us, this means progressing our client partnerships beyond operation engagements like cost takeout and labor arbitrage and developing higher value relationships that encompass real business effectiveness and innovation. Clients are increasingly turning to us because we can provide them with efficiency, effectiveness and innovation, on one single tightly-integrated global platform.

Greater business effectiveness is achieved through our continued improvement of service quality and the ability to commit to improved business outcome for clients. While innovation is achieved through partnering closely with our clients to source new avenues of revenue and productivity by devising new ways of orchestrating their business operations.

Our service delivery is enabled by our web 2.0 based platform which we call Cognizant 2.0 which is proving to be a powerful differentiator for us in the industry. Cognizant 2.0 allows us to bring all our expertise from around the world to bear on each and every client engagement. In the same way that web 2.0 social networking sites on the Internet have created a powerful networking effect, Cognizant 2.0 is connecting Cognizant associates, client and other stakeholders, allowing us to pool knowledge and experience across our global operations, and collaborate with clients in new and innovative ways.

To illustrate the power of our value proposition, I would like to mention our role as strategic global partner for Sanofi Pasture, the largest company developed and researching human vaccines, including the hyper critical H1N1, or swine flu vaccine. Sanofi Pasture has selected Cognizant as its global partner for clinical trial data management among other areas. Using a core team located in France, the US, and India. Today we're executing over 30 large clinical studies in partnership with Sanofi Pasture. Most notably we have helped the company meet agressive H1N1 deadlines on five critical studies.

Our partnership has allowed the company to increase effectiveness as measured by time to value and reduce process hiccups for bringing vaccines to market. Importantly, our pricing model at Sanofi Pasture is transaction and outcome based demonstrating the evolution of our services delivery model. Sanofi Pasture is also a great example of the power of the globally distributed teams to improve effectiveness, an approach that is central to our Cognizant 2.0 knowledge sharing platform. This engagement demonstrates many of the key dynamics that are driving the growth of our life sciences business. A focus on reducing operating costs, while at the same time driving greater effectiveness across the business. Our ability to give customers the best experience in the industry is a direct result of our strategy of aggressively reinvesting in our business.

Let me briefly update you on some of the key reinvestment highlights from this past quarter. Investment in building out our capabilities in BPO/KPO, and infrastructure management services remains a key focus area. Both of these service offerings have shown robust growth. In addition to our ongoing investment in talent, we announced two strategic acquisitions that will continue to bolster our capabilities in these two areas. First, in September, we announced the acquisition of the assets of Pepperweed Advisors which strengthens our IT infrastructure services practice by broadening our portfolio of consulting offerings, advising on business performance, risk management and infrastructure cost management.

Similarly, we have signed a definitive agreement to acquire the UBS India service center which boosts both our KPO and BPO and IT infrastructure capabilities. This transaction, which is expected to close at the end of this year, will also deepen our financial services domain knowledge, strengthen our geographic footprint, and serve as a platform for us to provide similar client -- similar services to other clients. We have also signed a multi-year agreement to provide a range of business process outsourcing, knowledge processing outsourcing, IT and remote infrastructure management services to UBS divisions around the world.

We also continue to invest in expanding our global delivery network. We opened our 52nd delivery center in Manila recently initially to provide BPO services. Also we expanded our Phoenix delivery center to include BPO services alongside application development, application maintenance, and testing. We have similarly expanded other sites in the US and Canada as part of our strategy to deepen our near-shore and in-country capabilities. Of course, while it is important to open new sites globally, the real challenge is not in bringing new centers online but rather how we stitch these centers together in a collaborative and integrated delivery platform. Cognizant 2.0 as I mentioned briefly is a powerful platform for integrating our global delivery network.

As a final note before I turn to our outlook for the rest of the year, I would like to highlight our operational execution for this quarter. As many of you know, over the last six quarters we have gradually increased employee utilization at Cognizant. Many of you have questioned the impact of higher utilization on our ability to ramp up to increased demand. This quarter demonstrates that despite running at historically high levels of employee utilization, we have processes to handle surges in demand and can ramp up to take advantage of opportunities when they occur. Our supply chain is tight and we are able to quickly translate demand signals to increased supply of talent. We continue to sharpen our ability to forecast demand, and the requirements of specific skills so that we can scale up while maintaining high levels of utilization.

Let me now turn to our outlook for the remainder of the year. We are guiding to revenue of at least 880 million for the fourth quarter and $3.255 billion for the full year. This represents a projected 3% sequential increase for Q4. Though we saw impressive results in Q3 and our pipeline remains robust, we are taking a justifiably cautious approach when providing Q4 revenue guidance based on several factors. First, although we saw an acceleration in decision making during Q3, as we go through the 2010 budget season over the next few months, we believe the demand factor may be less predictable than normal due to uncertainties around the size of budgets and timing of finalization. Our guidance assumes that the client decision making process will slacken and projects that come to a close may not yet immediately renewed until such time as clients finalize the year's budget. Additionally, a robust economic recovery seems unlikely in the near term. And hence, unlikely to create a catalyst for accelerated incremental discretionary spending. Finally, it should be noted that the fourth quarter has more holidays and thus fewer billing days than the third quarter. As a result, as in almost every year in the past decade we would expect slower sequential growth in Q4 versus Q3.

I want to make clear that despite the uncertainty of the pace of decision making in the coming months, the fundamentals of our business remain strong. Specifically, our pipeline is robust and we are actively engaged with clients to bring these opportunities to close. Our services portfolio is stronger than at any time in the past and key service offerings like IT infrastructure services and BPO and KPO are showing traction. Finally, our geographic expansion to new markets continues to show results and drive real growth.

Now I will turn the call over to Gordon who will detail our financial and operating results.

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 2009.

As Francisco mentioned, our strong revenue performance is broad-based, with all of our major industry segments experiencing healthy demand. During the third quarter, our financial services segment, which includes our practices in insurance, banking, and transaction processing, grew 9.5% on a sequential basis, and 7.4% year-over-year. It represented 42.7% of revenue for the quarter. We experienced healthy sequential growth in both the banking and insurance components of this segment. Within financial services, many of our key clients are indicating that the worst is over for IT spending reductions, and are more positive about the prospects for their 2010 budgets than a few months ago.

The current demand within financial services is fairly broad, including merger integration efforts, regulatory compliance, especially in our credit card business, and risk management where clients are developing systems to help better measure and manage risk. Health care continued its strong performance during the quarter, with 10.8% sequential growth and 30% growth compared to the third quarter of last year. We experienced healthy growth among both our life sciences clients and our health care insurance clients. This segment represented 26.5% of revenues for the quarter.

Retail manufacturing and logistics was also strong. Growing 10.7% sequentially, and 27.1% year-over-year. Representing 17.2% of revenues for the quarter. We are particularly pleased with the strength that we saw in our retail sector, where many of our clients are earlier in their transition to global delivery, and see the weak economy as a catalyst to accelerate these programs. In fact, revenue from our retail clients grew over 15% sequentially in the third quarter, as these clients completed projects prior to the normal holiday season development lockdown in the fourth quarter. The remaining 13.6% of our revenues came primarily from other service-oriented industries of communications, media, and high-tech which grew 8.4% sequentially, and 9.5% year-over-year.

For the quarter, application management represented 56% of revenues and grew 22% year-over-year and 10% sequentially. Application development was 44% of revenues, and grew 10% year-over-year, and just over 9% sequentially. During the quarter, 78.3% of revenues came from clients in North America, Europe was 19.2% of total revenue, and 2.5% of revenue came from the Asia Pacific, Middle Eastern, and South American markets. On a reported basis, Europe grew 18% sequentially in the third quarter.

Currency movement positively impacted European revenue growth in the third quarter on a sequential basis by approximately $6.4 million due primarily to the strengthening of the pound, Swiss franc and euro. However, compared to the third quarter of 2008, the movement of the European currencies negatively impacted growth by over $12 million. As anticipated on sequential basis, pricing remained relatively stable. We had a gross addition of 46 new customers during the third quarter. We closed the quarter with 570 active customers. During the quarter, the number of accounts which we considered to be strategic and have the potential to ramp up to at least $5 million or more in annual revenue, increased by five. This brings our total number of strategic clients to 139. We continue to see the trend towards our newer strategic customers embracing a wider range of Cognizant services, at an earlier stage in the relationship.

Turning to costs. On a GAAP basis, cost of revenues exclusive of depreciation and amortization, increased 17.2% for the quarter, as compared to the third quarter of last year. Third quarter cost of revenues included approximately $3.3 million of stock-based compensation expense as well as the reversal of $192,000 of stock-based Indian fringe benefit tax expense. This reversal is due to the repeal of the Indian fringe benefit tax during the third quarter, retroactive to April 1, 2009. The increase in cost of revenues is primarily due to additional technical staff both on-site and offshore, required to support our revenue growth. We increased our technical staff by more than 3,800 during the quarter. And by approximately 8,200 compared to September, 2008. We ended the quarter with over 63,600 technical staff.

Third quarter SG&A, depreciation, amortization expenses were $216.1 million on a GAAP basis, up from $162 million in the third quarter of 2008. GAAP SG&A expense at Q3 of 2009 included approximately $8.6 million of stock based compensation expense and the reversal of about $1.1 million of stock-based Indian fringe benefit tax due to the repeal of the Indian fringe benefit tax. GAAP operating income for the quarter increased approximately 13.4%, to $161.8 million. On a GAAP basis,(Sic-see press release) which excludes the impact of $11.8 million of stock-based compensation expense and the reversal of $1.3 million of fringe benefit expense, operating income for the quarter was approximately $172.4 million, up 12.8% from last year.

Our GAAP operating margin was 19% for the quarter. Our non-GAAP operating margin which excludes stock-based compensation expense, and stock-based Indian fringe benefit tax impact, was 20.2% for the quarter, just above our target range of 19 to 20. The margin overperformance was primarily driven by our continued improvement in utilization, in the higher anticipated revenue during the quarter partially offset by an increase in our variable compensation expense.

The average rate for the ruby was 48.3 in the third quarter of 2009, versus 48.7 in the second quarter, and 43.7 in Q3 of last year. $90 million of rupee operating expense cash flow hedges settled in Q3. This resulted in a gain of approximately $2.6 million, which was recognized in operating expenses. For the remaining quarters of 2009, we have an outstanding forward contract for hedges of $88.9 million, of rupee operating expenses, at an average rate of 49.6. In addition, we currently have $450 million of rupee operating expense hedges in place for 2010, at an average rate of 49.4, and $360 million for 2011, at an average rate of 48.5.

Interest income for the third quarter is $4.7 million, compared to $5.3 million in the third quarter of last year, and $2.6 million in the second quarter of this year. Interest income has declined year-over-year, due to the continued decline in short-term interest rates compared to last year. We had a $2.7 million of non-operating expenses. This was comprised of a net $2.9 million foreign exchange loss during the quarter, related to balance sheet remeasurements, and associated hedges primarily associated with the movement of the dollar versus the rupee, pound, and euro. The remaining $200,000 in nonoperating income resulted from the mark-to-market requirements related to our auction rate securities portfolio.

Our GAAP tax rate for the third quarter was 16.6%, we expect a full-year 2009 tax rate to be approximately 16.5. As we mentioned on our second quarter earnings call, the Indian government has extended the benefits of certain of our tax holidays through March, 2011, which had been scheduled to expire in March, 2010. Our diluted share count for this second quarter was 302.6 million shares. We did not repurchase any shares during the third quarter under our 2008 Board-authorized repurchase program.

Turning to the balance sheet, our balance sheet continues to strengthen. We finished the quarter with approximately $1.34 billion, of cash, short-term and long-term investments. Up over $195 million from the end of Q2. During the quarter, operating activities generated over $208 million of cash, financing activities generated over $21 million of cash. Comprised of the proceeds of option exercises and related tax benefits, as well as our employee stock purchase program. We spent approximately $32 million for capital expenditures during the quarter, and $4.5 million for acquisitions and related costs. In addition, we benefited from approximately $2 million in currency translation adjustments.

For full-year 2009, we expect to spend between 100 million and $120 million of capital expenditures. This is a further reduction from our original expectations due to the timing of our new facilities and infrastructure requirements. Based on our $685 million balance on September 30, we finished the quarter with a DSO, including unbilled receivables of 74 days, compared to 75 days in the same period of 2008. The unbilled portion of our receivables balances is approximately $98 million at the end of the third quarter, an increase of about $15 million compared to Q2. Approximately 63% of the September 30, unbilled balance was billed in the month of October.

During the third quarter, 31% of our revenues came from fixed price contracts, up from 30% in the second quarter of 2009, and up from 26% in the third quarter of 2008. When we look at the mix by solution type during the third quarter, 32% of our development revenue, and 30% of our maintenance revenue came from fixed price contracts. We are pleased to continue the trend of increasing the percentage of our revenues coming from fixed price contracts.

Turning to head count, at the end of the third quarter, our worldwide head count, including both technical professionals and support staff, totaled over 68,000. This represents a net increase of over 3,900 people during the third quarter. Annualized turnover, including both voluntary and involuntary, was approximately 12.3% during the third quarter. Third quarter attrition represented more than a 500 basis points improvement versus the third quarter of 2008. As discussed previously, our medium term strategy has been to increase the Company's utilization levels due to scale economies, and historical heavy overinvestment and bench resources. Q3 results show a continued payoff on this strategy. Offshore utilization was approximately 74% during the quarter. Offshore utilization excluding recent college graduates who are in our training program during the quarter was approximately 78%. On-site utilization was approximately 90% for the quarter. At the end of Q3, we had over 3,400 unbilled people remaining in our training program.

I would now like to comment on our growth expectations for the remainder of the year. For the fourth quarter of 2009, we are projecting revenues of at least $880 million. We 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 fourth quarter revenue guidance. For full-year 2009, we continue to expect industry-leading revenue growth, based on current conditions and client indications, we are increasing our prior guidance and expect revenue of at least $3.255 billion. This represents growth of at least 15.5%, compared to our prior guidance of at least 11.5%.

As Francisco mentioned earlier, our strategy of aggressive reinvestment is delivering results, and we intend to continue this strategy in the fourth quarter. Therefore, we are expecting our operating margin for the remainder of this year to be in our historic range of 19 to 20%, before the impact of equity-based compensation expense. Therefore, we are comfortable with our ability to deliver in Q4, GAAP EPS of $0.45, and nonGAAP EPS of $0.49, which excludes estimated stock-based compensation expense of $0.04. This guidance anticipates a Q4 share count of approximately 305 million shares, and a tax rate of 16.5%. The guidance excludes any future nonoperating FX gains or losses. For full-year 2009, based on current business trends we are increasing our GAAP EPS guidance to $1.75 from our prior guidance of $1.66 and now expect our full year non-GAAP EPS to be $1.88 excluding $0.13 of stock compensation and fringe benefit tax expenses. This guidance anticipates a full year share count of approximately 301.2 million shares and this guidance also includes any future nonoperating FX gains and losses. With that we'd now like to open the call to questions. Operator?

(Operator Instructions) Your first question comes from the line of Brian Keane with Credit Suisse.

Wow, super quarter, guys. Just wanted to ask about, as the demand comes back, and hiring picks up, can you keep the offshore utilization this high? And I think it was 74% for the quarter. Or should that drop as we pick up the hiring?

You will see more volatility in the utilization number including the trainees, because we will be bringing on a bunch of of trainees. Excluding trainees, we're pretty much at our target level. You will have some volatility up and down but no material trends one way or the other.

Okay. And just like to ask about pricing. What is the pricing environment look like right now? And then the second question is, there has been a lot of talk about wage inflation in the industry. Some of your competitors have been talking about increasing wages. You can talk about what you guys are doing there? Thanks a lot.

Sure. As I mentioned, pricing is playing out the way we expected. It is essentially stable during the third quarter. It was up a little bit on-site. Down a little bit offshore. And some of that offshore is mixed as BPO and IT, IS obviously grew faster than the rest of the business but I think the message is quite consistent with a lot of the other top players are saying, there is certainly stability in the market in terms of pricing.

Wage inflation for 2009, we have taken the approach of clearly sharing the success of the Company this year with our employees. And as I mentioned, we increased our variable compensation accruals and we expect to pay out healthy bonuses to our employees who made the success possible. Obviously, there are two ways we could have done it in 2009. We could have increased base salary like a couple of the competitors have done but we think it is more appropriate to have a direct link between performance and rewards for our employees. And we think our employees can be happy and we keep that as a variable expense. For 2010, too early to know how things will play out.

Okay. Congratulations.

Thanks.

Your next question comes from the line of Rod Bourgeois with Sanford C. Bernstein and Company.

Yes, just wanted to inquire about the budgeting process. Are you getting early signs that this will be more of a normal budget timing season? Or are you expecting that we may have hiccups in the budgeting process as we've had in past years? And if you can specify when at this point you expect to get clarity on your clients 2010 plans, that would be very helpful.

Sure. Let me take that. As I said, our planning assumptions at this point are that we will see somewhat of a slackening of demand as clients go through the budget cycle. And our planning assumption is that the budget cycle will take a little longer this year than it would in say a normal year. I don't think -- the indications we have right now are that it won't be like it was during the 2009 cycle where budgets really didn't get finalized until, in many cases, until the second quarter. So I'm expecting that budgets will be finalized by late in the first quarter at the outside. But it is still too early to have a definitive view into that. I think many of our clients are taking somewhat of a wait and see approach to see how this quarter comes in, and how things look for the rest of the year before they make a final commitment as to when they're going to lock down the budgets. So too early to tell when we will have a definitive view into the finalization. But right now, we're presuming, assuming it is going to be toward the end of the first quarter.

Last year, you did your customer conference, and then gave your guidance right after that, in the mid February time frame. Is that the plan for next year as well?

No, the timing is going to be different. Just due to a bunch of logistics. We are going to have our customer conference in April.

Okay. Great. And then in terms of areas of growth, were there any areas of the business where the growth was just surprisingly strong? I mean we're hearing that the REMO remote structure outsourcing business for you guys is getting very good traction. Was that an area of sort of growth surprise or were there other areas in your business that were just particularly pleasing in terms of the growth breakout?

Let me highlight three or four areas for you. First of all, I think the stabilization and return to growth in the DFS sector is worth highlighting. Clearly, we're hearing from clients that the worst is behind us, in terms of cuts and slowdowns in that sector, so that was -- we had seen that a little bit in Q2, but it was nice to see that continue through Q3, and as you saw in the quarterly sequential number, DFS came back very nicely with 9.5% sequential growth. Other places that I will highlight, we had a very strong quarter in our retail business, retail as a group grew as a sub group within the retail manufacturing and logistics segment, grew 15% sequentially. So very strong quarter. Part of that was driven by the fact that there was a lot of -- a lot of things that our retail clients wanted to get done, and locked down, by the end of the third quarter, getting themselves ready for the so-called golden quarter, the fourth quarter, the shopping season and so on and so forth. So that was the second one I will highlight. And then like you pointed out, the infrastructure business, the infrastructure management business and our BPO business continued to grow very, very nicely for us. They grew about 18% sequentially, on a combined basis during the third quarter. So strong growth in those businesses as well.

All right. And one final quick one. Gordon, should we expect your operating margin to drop back into the target range for 2010, as you invest more in growth? Is that the explicit expectation that we should have at this point?

You should expect we will be back in the target range in Q4 as well as in 2010.

Thanks, guys.

Thank you.

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

Thanks. Nice quarter. Gordon, when we're modeling our 2010 quarters how should we think about kind of the progression of the quarters? Should we assume kind of the typical seasonality? And then can you also comment on the effective tax rate for next year and maybe in 2011? And are we at a stage where we should start seeing -- continue to see application development revenues accelerate from here?

Let me start with the tax rate. We would not expect any material change one way ort other in 2010. If there is no change in regulation, and that's a big if, because there is a lot of discussion going on for 2011, but if there were no change, we would have a material increase in 2011, as the STPI holidays go away. But India's government has put out a proposal looking at a fairly broad revamp of the tax structure. So it is really too early to predict 2011. In terms of seasonality next year, as you know, our normal seasonal pattern is Q2 and Q3 tend to be our strongest quarters. Whether that will play out again next year or not, one will depend on the timing of the budget cycle, and then in Q4 of next year, do you have a budget flush or not. But typically, Q2 and Q3 of each year tend to to be our strongest quarters. And you had a third part which I forgot.

The third part is application development revenues. Should we continue to see an acceleration from here?

A little too early to know. Both Q2 and Q3 on a sequential basis essentially both maintenance and development grew at the same pace which is a big pickup in development from the year prior. Do they continue at the same pace? Does development start to outpace maint maintenance? A little too early to know for next year.

That's fair. And then final question about 2010 budgets any preliminary commentary about the direction of 2010 budget, in terms of growth or declines? And then what do you think about clients' funding commitments towards offshore related projects, for next year as well?

Two parts to that. I think that in general, as we've been saying for some time now, the slowdown has created an acceleration in clients in thinking about the offshoring lever from their standpoint, so they're looking to see how they can outsource in offshore, increasingly more, optimize their offshoring programs, and as I said, they're not just looking at it from a standpoint of efficiency, or cost savings, or labor arbitrage, we're now having discussions with them about how to help them make their businesses more effective, how to help them innovate, and generate revenue on the top line, so the types of conversations we're having are broadening well beyond the traditional cost savings, operational excellence and labor arbitrage type of conversations.

Directionally in terms of where budgets are headed, I think it candidly, we have a little bit of everything. There are some clients that -- where budgets will be down slightly, I'm not hearing anything about across the board dramatic reductions in budgets. I'm hearing flat to slightly up in some cases. So it is really all over the map. But I don't think you're going to see dramatic increases or dramatic decreases in budgets going into next year.

Thanks, guys. Nice quarter.

Your next question comes from the line of Ed Caso with Wells Fargo Securities.

Good morning. Congrats as well. A lot of your competitors have talked about nonlinear growth and curious how you view that comment, and maybe any efforts you might be doing, sort of beyond utilization and fixed price.

So I think, Ed, we have a series of initiatives under way to look at nonlinear revenue growth opportunities in all of our businesses. And I would categorize them in a couple of different areas. The first is in the core businesses, our core horizontals and verticals, our service lines and verticals, we're looking at each and every service that we offer clients and putting together transaction-based, or outcome-based pricing models for those businesses. So for example, the Sanofi Pasture example that I gave dure the call is an example of a place where we're working with the client on outcome-based pricing. Some of our service offerings like IT infrastructure services and BPO lend themselves very much to outcome and transaction based pricing. So we're focused on those areas, where the underlying nature of the services lends itself to transaction-based pricing.

On the other side, you know, sort of more in what I would consider at this point very much in the R&D bucket, we're looking at platforms like Cognizant 2.0, the possibilities of cloud technology, and things like software as a service, all as possible ways to create nonlinear growth -- nonlinear growth opportunity force the company but I would categorize those as R&D investments or R&D investments at this point as opposed to projects that will deliver nonlinear revenue growth in the next few quarters.

Gordon, could you set a size of the BPO business for us, percent of revenue, growth rates, where you think it is going, and implications on sort of your average price?

Sure. BPO's give or take 5% of revenue today, clearly growing materially faster than the rest of the business. Much more heavily offshore than the rest of the business. And average billing rates will be lower. But obviously labor costs are lower as well. So we're starting to get traction there. We're very pleased with both the traction we're getting in BPO and infrastructure management.

Thank you.

Your next question comes from the line of Jason Kupferberg with UBS.

Thanks. Good morning, guys.

Good morning.

So you have obviously had some great revenue outperformance each of the past two quarters here and I just wanted to get a sense of how much of this you would characterize as pent-up demand, if you will, converting to revenue faster than you had anticipated, as opposed to underlying customer spending trends and proving on a sustainable basis? And what I'm trying to get a sense of is as the materialization of the pent-up demand holds forward revenue that you originally might have thought would not have come into 2010, just kind of trying to pars out those pieces as we start to think about potential growth trajectory of the Company next year?

It is obviously very difficult to try to quantify that distinction you're making with a great degree of precision, so I can just give you qualitative comments around that. I think that the revenue overperformance we've seen is a little bit of both. I think there is a little bit of pent-up demand if you will. I think clients put things on hold during the worst of the recession, that were not absolutely core to keeping the business running or keeping the lights on. And as the environment has stabilized a little bit, those projects are coming back. So there is a little bit of a backlog of those projects, and like I said, what was surprising to us in the quarter was the pace at which decisions were made on those projects. What I don't think, we're not assuming that the revenue outperformance that we've had in the third quarter translates into, if you will, a new normal or a new baseline of spending going forward. We do think that there was somewhat of a surge as a result of these projects getting approved, and that will return to some level of normal going forward. Which is what is reflected in our fourth quarter guidance.

Okay. That color is very helpful. Just wanted to probe on the wage front a little bit more. I know you said 2010 is still kind of a TBD here. Obviously some competitors made some offcycle decisions. I think you guys normally make your decisions effective July 1. Is there the potential that you might move up that time frame for making your decisions, just given what might be happening in the competitive environment? Or you feel like some of those moves by other vendors are really more of a catch-up kind of thing, rather than fully pulling ahead on the wage front?

We will continue to be fully competitive on total compensation in the marketplace. You have to separate variable and base. This year, I would expect we will probably pay the highest bonuses in the industry. But others put it into base salary. We think it is good to have a direct correlation between performance and reward. It makes people very motivated and they see, they see the direct benefits of their efforts. What we do next year will depend on what other competitors do but once again we have been, are and will continue to be fully competitive from a total compensation standpoint in the marketplace.

Last one for me. I think you touched on this a little bit in the prepared remarks, but when you think about the average number of service offerings that are currently being used by your strategic customers, within their first, I don't know, 12 or 18 months of being a client of Cognizant, can you characterize that number, and then talk about how much potential upside remains there?

I think a couple of qualitative comments there. First of all, like we've said I think in the past two quarters or so, we mentioned it on the call, the -- what we're seeing is a trend where new customers are increasing -- are adopting a broader range of services more quickly than we've seen in the past. So in the past, it wasn't an unusual trend for us to sell one service offering, get that stabilized with the client, and then cross-sell other service offerings around that a year or two later. Now what we're seeing is increasingly clients find multiple services from us, within the first year or two of their engagement with Cognizant, so we're seeing an acceleration from that standpoint.

I don't have the number with me right now. But if I were to look at the -- if you could categorize say we have four major service groups, application services, BPO services, IT infrastructure services, and consulting services, these are the four major groupings, it is still a minority of our customers that use us for all four of those service offerings.

Okay. That's great color. Thanks, guys.

Your next question comes from the line of Nabil Elsheshai with Pacific Crest Securities.

Hi, guys. Thanks for taking my question. First just to follow-up on the retail strength. Do you have a sense how much of that was, as you said was the seasonality of getting stuff down before Q4 versus retailers maybe coming back to an increased investment in IT spending?

Look, I think it is both. To be candid with you. I think that the retailers are certainly coming back to spending, and you also have to understand that retailers -- retail as an industry has been relatively underpenetrated from an offshoring standpoint, so there is natural opportunities for retailers to move work offshore. Having said that, retail has always, in good times and in bad times, had the phenomenon of locking down, or significantly locking down during the so-called fourth quarter, the golden quarter. Because they just don't want to introduce uncertainty and risk during the important quarter, from new systems, and going into production. So I think that a little bit of the Q3 overperformance was due to getting stuff done by the end of the third quarter, but there is an underlying trend here of retailers increasingly moving to an offshore model.

Okay. And then on the competitive front, you mentioned a couple of times having increasingly strategic conversations with your clients. Does that put you in a different competitive category or put you more up against the multi-nationals?

Certainly. I mean for several quarters now, what we found is that in an increasing number of our engagements, our competitive set has been -- has included the multi-nationals. Obviously, still a significant number of situations where we're competing against the India players as well, but we are increasingly finding ourselves in competition against the multi-nationals, and the traditional SI and consulting firms.

And then last question, on hiring, any color you can give on the rate of hiring and also some of your competitors have been setting up more near-shore, including in the US development centers, any plans for that with you guys?

Let me talk about the near shore centers and then I will turn it over to Gordon on the color on hiring. As we said, during the quarter, we opened a development center in Manila, but we also significantly expanded our near shore and in-country US capabilities. We expanded our facility in Toronto, Canada, for near-shore, we expanded the Phoenix facility to include new -- BPO as a new service offering but we also expanded two or three of our local in-country other local in-country US delivery centers from a -- just from a capacity standpoint. So we did quite a lot during the quarter to expand our in-country and our near-shore capabilities for US customers.

In Q3, we significantly accelerated both our lateral hiring and the intake of the college graduates. When we look at the intake of the college graduates, we both accelerated, finishing p the 2008 class, as well as accelerating the intake of the 2009 class. And in fact, we're -- in a another couple weeks we will be on campus starting to recruit for the 2010 class. So we have a good pipeline. And we're bringing the people on sooner than expected. And more importantly, as we need to go into the market for lateral hires, we have been very successful and expect to continue to be very successful in attracting the best and the brightest to Cognizant. Obviously, our growth provides unique career opportunities for people, and I think many people realize, joining a company that is the market leader in terms of growth provides career opportunities that may be difficult to find elsewhere. So we will continue to hire aggressively as we finish up this year, and then depending on what demand characteristics are next year, we will have a very robust pipeline.

Great. Thank you.

Your next question comes from the line of Glenn Greene with Oppenheimer Funds.

Thank you. Good morning. And congratulations as well on the quarter.

Thank you.

I guess the first question, I wanted to go back to sort of the quicker decision-making that happened in the quarter, which drove some of the upside. Could you give us some color on sort of how the pipeline has been replenished post the quarter? And just maybe a little bit of color across verticals, how the pipeline going forward is looking?

I think that all of our pipeline metrics remain strong, going into the fourth quarter, and the pipeline, traditionally, Glenn, the fourth quarter is a strong pipeline quarter for us, because even though budgets are not approved, clients start to discuss potential projects with us in preparation for budgets getting approved. So we have a very strong pipeline going into the fourth quarter, and I see no signs of -- reasons to be concerned on the pipeline side, as we go into the fourth quarter.

In terms of color, the pipeline, if I break it down, is largely consistent with the trends that we have discussed broadly in the business, both in terms of strong -- well balanced I would say across the verticals, and horizontals, and service offerings and well balanced across the geographies. We -- I think there might be, for example -- there might be some small pockets, in retail for example we might not see quite as strong growth in the fourth quarter because of the lockdown issues and so on and so forth, but at a macro level and take a 50,000-foot view, the pipeline is fine for the fourth quarter and going into next year.

Then just quickly for Gordon, could you give us what the incremental incentive accrual was in the quarter?

We haven't broken out this specific amount but it certainly reflects the stronger performance that we're realizing both in revenue and operating performance, and certainly picks us to have at least among major players the strongest variable payout in the industry.

Okay. Thank you.

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

Hi, guys. Nice work. I was wondering if you could tell me a little bit about what volumes were like this quarter maybe compared to last quarter and just talk a little bit about any element of discretionary spending that maybe you saw sort of continue this quarter.

Sure. The vast majority of the growth was volume related as we mentioned. Pricing was give or take relatively flat. No material movements in on-site, offshore and a little extra in terms of billing days but this is -- the vast majority of this was volume related. Sorry, what was the second part of your question?

The second part was I know you talked about maybe June maybe seeing a spark of discretionary spending. It looks like this quarter that kind of grew. I wonder if you could just talk about the flow of discretionary spending this quarter maybe heading into next.

The trend really started in Q2. That was the first quarter since 2007 where development, which is used as a proxy for discretionary spending grew at the same pay sequentially as maintenance, and that trend continued in Q3. Q4, will that trend continue or not? It will sort of depend on do people kick off the new projects, or not? We have been a little bit more conservative with our assumptions on development spending in Q4 because that is obviously more discretionary.

Was there a large project in the third quarter that maybe began and ended or is it just continuous work?

The strength in Q3 had nothing to do with one project or one customer. As we indicated, it was across all of our industries. It wasn't one industry driving this. It was across all of the industries and geographies, so it was quite broad-based.

And then just lastly, as we kind of exit this year and head into next year, you have seen sort of a baseline level of maintenance work, maybe in the March quarter and if I understand it correctly, you've seen some discretionary pickup in the last three quarters, and is it your thought that with budgets sort of finalizing, that maybe we would be building off that base heading into 2009, and that incremental revenue would be based on sort of where what you're going to see on the discretionary side?

A lot of it is -- there is a timing question in here. When will budgets be finalized and how big will the budgets finally be. As Francisco mentioned, given we still are in a difficult economic environment, we are being conservative on our assumptions about when budgets get finalized and the lumpiness that results while people are going through the budget process.

Okay. Thank you.

Your next question comes from the line of George Price with Stifel Nicolaus & Company.

Hi, thanks very much. Again, congratulations. A lot of my questions have been answered but I did want to follow up on a couple of things. First, Gordon, from the margin perspective, I know, recognize what you said regarding the -- back into the standard margin range, but I guess if we kind of look around a little bit, look at how some of your offshore competitors have at least maintained their margins at pretty good levels, seeing some improvement, surprising improvement say from IBM for example, even in their outsourcing business, I'm just wondering, given where the business is trending, and inflecting here, do you think the 20% level could be a more reasonable consistent level still given the pace of the acceleration of the revenues, to still let you invest and yet have it at a somewhat higher margin level?

We're still in the early innings of this whole trend towards globalization, and especially as we're moving up the food chain with our consulting capabilities, with our IT/IS capabilities and overlapping more and more with the multi-nationals. Would very tremendous market opportunities left. So we're in this for the long term. And our strategy is to invest -- and our strategy is to invest for the long term so we grow materially faster than any of our competitors. That's how we measure success. We do not measure success on increasing our margin. Our goal is to maintain our margins at 19 to 20%. And take every dollar above that to reinvest in differentiating ourselves from the rest of the market and as a result growing the top line faster than the other major players in the market.

Okay. In terms of segueing to some of the multi-nationals, have you seen any changes in what they're doing competitively, are they reacting any differently given pressures from the macro downturn, particularly the more I guess successful M&T's out there in Accenture and IBM?

I wouldn't characterize the competition or the competitive nature to be any different as a result of the macro economic environment. I mean beyond the trends that we've been talking about for some quarters now, with them increasingly using the offshore and global delivery model, in their deals and so on, I don't see a significant change. As I said, the last one or two quarters. I think that the place where we continue to be successful is in terms of creating a truly integrated global delivery network using our Cognizant 2.0 delivery platform, which allows us not just provide essentially talent in different parts of the world but to stitch that talent together in a seamless cohesive global team and we find that to be a very strong value and very compelling value in the marketplace. Both when compared to our traditional India-based competitors and the multi-nationals.

Okay. Last question. Gordon, just given the CapEx pushouts this year, can you maybe give us a sense of how that might play out in terms of CapEx next year? And then if you -- I don't know if you gave the percent of employees in India, if you could give that, that would be helpful. Thank you.

Sure. We're still going through the planning process for next year. Certainly I would expect that will initiate an additional round of construction. How big and the timing of that, just not quite sure. In terms of the on-site offshore mix, very small change this quarter. We moved on-site by about 30 basis points compared to last quarter.

Okay. Great. Thank you.

And with that, operator, we have time for one more question.

Your last question comes from the line of Ashwin Shirvaikar with Citigroup Inc.

Hi, thanks for taking my question. Just for clarification, does your guidance include any UBS India contribution?

To be very clear, no it does not. We expect that acquisition to only close at the end of the year. So Q4 does not include any UBS revenue, and we don't expect any material impact from it.

Okay. And as you look at your cash buildup, just to follow up on that last question, any commentary on the M&A beyond UBS India, or just some of your India-based competitors have done things like special dividends and stuff like that. Any commentary there?

Our strategy is unchanged. We continue to look at the smaller tuck-under acquisitions. Those have been very successful for us. We're thrilled with the ones that we've done this quarter. We think they add very targeted and meaningful capabilities to the Company so we continue to look at those. Other than what we've previously announced there are no other plans at this point.

Okay. Good luck, guys. Thanks.

Okay. Thank you.

Thanks. Let me just close by saying that we're absolutely delighted with our performance during the third quarter. Despite a very difficult operating period in the economic environment, Cognizant remains an industry-leading provider, thanks to our business model, our continual reinvestments, our operating efficiency, and the strength and passion of our people. Thank you all for joining us today. And we look forward to speaking to you again next quarter.

Thank you. This concludes today's conference call. You may now disconnect.