高知特 (CTSH) 2010 Q3 法說會逐字稿

Ladies and gentlemen, welcome to the Cognizant Technology Solutions second quarter 2010 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 Investor Relations and Treasury at Cognizant. 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 2010 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.

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. Frank, go ahead.

Thank you, David and good morning everyone. Thanks for joining us today.

I'm happy to report that Q3 was another strong quarter performance for Cognizant. Third quarter revenue was $1.2 billion, a sequential increase of 10% and an increase of 43% year-over-year. We maintained our non-GAAP operating margin at the high end of our target range and we achieved record cash flow level. For the third straight quarter, application development grew faster than application maintenance by a strong margin. Maintenance grew 6% sequentially, while development, an indicator of discretionary spending, grew 14%. Again, this quarter, our growth was broad based across sectors, geographies and service offerings.

A portion of the growth in discretionary spending in the third quarter was the tail end of pent-up demand created by two years of cost cutting and conservative spending, but we think more significantly, the overall increase in spending over the last two quarters or three quarters, excuse me, is a validation of our view that our clients are dealing with more than the aftereffects of a cyclical downturn. As I've said on past calls, the major industries that we serve are going through fundamental secular changes.

The secular changes that we see clients addressing are driven by three global trends that are rapidly reshaping the way forward-thinking companies operate. These trends represent three pillars upon which a new normal in some sense for companies is defined. The first pillar is a new generation of highly distributed and virtualized business models. These models are pushing global talent integration to new levels, in search of dramatically better efficiency and effectiveness.

The second pillar is a new generation of technologies, loosely labeled under the umbrella of cloud computing, these technologies, including Web 2.0, mobile computing, and social computing, and cloud computing that are once again changing the price performance curve of technology and are redefining the range of business problems that technology can help address. And the third pillar is a new generation of workers and consumers, so-called Millennials, who grew up with technology and have dramatically different expectations about how they interact with companies, both as employees and also as consumers. These three pillars that is new business models, new technologies and new generation of workers and consumers, form the foundation of a new future of work.

We see clients increasingly turning to Cognizant as they make the investments necessary to adapt to these structural changes, as evidenced by our strong performance over the past few quarters. This morning I want to elaborate on these three pillars and highlight how Cognizant's heritage and investments have prepared us to help clients address these challenges. Gordon will then present our detailed financial and operating results and as always, we'll close with your questions.

So let's jump into the future of work. The first pillar that I spoke about is new generation of highly distributed and virtualized business models, and while globalization of services is not new, we see clients pushing the envelope on what activity they feel comfortable outsourcing, and increasingly demanding a more variablized cost and consumption model. Traditional organizational boundaries have given way as work migrates to its right location worldwide, allowing companies to leverage expertise anywhere and everywhere it resides. Complex and dynamic end-to-end processes that were once performed by a self-contained workforce are now performed by globally distributed virtual teams that regularly include outside partners.

We see this clearly from the rapid growth of new services such as IT infrastructure services, business process outsourcing, engineering and manufacturing services and enterprise analytics. Clients are outsourcing while partnering on activities that two to three years ago, stayed well within the walls of the corporation. Our ability to successfully deploy and orchestrate these new business models, a product of our investments, differentiates us. Investments in sophisticated technology like Cognizant 2.0 or our on target infrastructure management platform that seamlessly connect our virtual work -- our virtual workforce with that of our clients. Our investments in large scale program management and advisory capabilities such as those our business Consulting Group offers, with the support of our recent acquisition of PIPC, are also investments in this area.

The second pillar is the rapid growth and adoption of a new generation of technologies that are social, mobile and cloud-enabled. Consumer technologies now far surpass the capabilities found in many enterprises. The monday morning corporate technology experience is far different from the ease and richness of communication, collaboration and connectiveness experienced on sunday night by the consumer. The technologies that have had a transform effect on people's personal lives remain largely absent from most workplaces. In response, we are helping our clients create a consumer-grade experience within the enterprise which is possible with these new technologies.

We offer clients a range of pay as you go or pay as you need business models, including software as a service and business process as a service, to help companies variablize costs and dramatically improve the end-user experience. A great example of this is our recently announced contract extension with 3M, where we've implemented a novel new IT as a service model that gives 3M the ability to consume our services on demand. Another example is Cognizant's proprietary platform for pharmaceutical sales force planning that we have developed and host. Based on Cognizant proprietary intellectual property, the platform allows clients to dramatically improve the effectiveness of their sales operations. We currently have commitments from several leading global pharmaceutical companies to manage thousands of sales professionals through either a software as a service or a business process as a service based model, which allows us to create completely variable, new delivery, user based pricing structures for our clients.

And, finally, through deep collaborative partnerships with leading cloud providers including firms like Microsoft, salesforce.com, and Amazon, we are helping clients adopt these technologies by leveraging infrastructure as a service and platform as a service models. For example, we recently helped a leading information company develop a strategy to move their applications off their own infrastructure and into the cloud. We're now in the process of deploying the first of those applications on Amazon EC2, which is their cloud computing platform of choice.

All of this brings us to the third pillar of change, which is the rise of the Millennial Generation. A major shift in the nature of work coincides with the growing presence of consumers and employees that are Millennials, people roughly between the ages of 18 and 29. This first generation of digital natives brings a mind set of collaborative problem-solving shaped by high bandwidth, always-on connectivity and Web 2.0 technologies. This perspective, less related to age than behavior, is reshaping everything from recruiting and retention to communications and innovation.

To help clients adapt to this collaborative mind set, CBC or Cognizant Business Consulting, and our customer solutions practice have been engaging with customers to add a social layer on top of core business processes, a classic example of this is designing social customer relationship management systems or social CRM. These systems incorporate public social media tools, like Facebook or Twitter, to engage customers in a two way dialogue to influence purchasing decisions or resolve customer problems. The confluence of these three unstoppable forces coupled with a highly dynamic regulatory environment will have a profound impact on how work is conducted and how value is created, especially in the complex knowledge industries -- knowledge intensive businesses that we serve. We call this the future of work, and it's no longer in the future.

Cognizant recently commissioned a survey of more than 400 senior executives who revealed that the future of work is not on the distant horizon. They are already embracing more global and virtualized operating models. One in three respondents said that they are already seeing or expected that collaborative virtual environments would have a measurable return on investments within a year.

We also recognize that the future of work is an ever-evolving concept, and that's why Cognizant recently announced a joint relationship with Carnegie-Mellon University to establish The Future of Work Research Center. This Center will study the technological and social systems -- system enablers of next generation organizations. The goal is to continue to develop ideas that will extend the use of social platforms in ways that will help advance the many systems of the world.

Let me now turn quickly to our 2010 guidance and outlook for the near future. Looking ahead for the rest of 2010, we are cautious about the macro environment and regulatory climate in key economies, but remain optimistic. Given strong Q3 performance, we've increased our revenue guidance to at least $1.27 billion for next quarter or at least $4.55 billion for the full year.

Beyond this year, we see three demand drivers over the medium term. The first is the growth of traditional outsourcing across IT business process and infrastructure. Clients continue to search for cost savings in order to fund growth and innovation in other areas. At the same time, the industry has matured to a point where the benefit from labor arbitrage is strongly complemented by the improved efficiency and effectiveness that third party providers like Cognizant are delivering. Taken together, these two factors are stimulating companies to reconsider what is their core to their business and what should be outsourced.

The second driver is the new slate of domestic and international regulations. This is particularly prevalent in the financial services and healthcare industries, two industries where we are extremely strong. And the third demand driver is near term Future of Work projects. Although the Future of Work is a long term journey for clients, we've already started to see clients take the first steps. As I mentioned earlier, the traction over the past few quarters in new services we have invested in like ITIS, BPO, social CRM and so on, are evidence of this.

With that I'll now turn the call over to Gordon, who will explain our financial and operating results in more detail before we move into the Q & A section. Gordon?

Thank you, Francisco, and good morning to everyone. As Francisco mentioned, our strong revenue performance is broad-based, with all of our major industry segments experiencing strong demand. During the third quarter, we continue to experience strength in our financial services segment, which includes our practices in insurance, banking, and transaction processing. This segment grew 10.5% on a sequential basis and 42.9% on a year-over-year basis, and represented 42.8% of revenue for the quarter.

The current demand within financial services continues to be fairly broad based across our client base. We're seeing continued focus on initiatives to drive cost efficiencies and operational effectiveness, projects related to regulatory compliance and risk management, discretionary innovation initiatives to enhance competitive positioning, and finally, M & A integration work, which we expected to ramp down during the quarter, was extended through the latter part of 2010.

Healthcare continued its growth during the quarter with 7.4% sequential growth and 33.9% growth compared to the third quarter of 2009. The segment represented 24.9% of revenues for the quarter. We experienced similar sequential strength among both our healthcare insurance clients and our life sciences clients. Demand within these clients was driven by data warehousing and analytics services to better understand and control medical costs, expansion of BPO services, including clinical operations, claims, benefits coding and enrollment, IDC-10 code set and 5010 assessment remediation work, and platform modernization initiatives.

Retail manufacturing logistics were once again very strong during the quarter. This segment continued to build on the growth from the first half of the year and 2009, growing 13.3% sequentially, and 57% year-over-year. It represented 18.9% of revenues for the quarter. Demand within this segment was driven by an increase in large scale transformational and system integration projects among our major manufacturing clients.

For our retail clients, we've seen an increase in business transformation projects, such as service platform development, modernization of core retail systems and multi-channel expansion, especially in eCommerce. In addition, we have seen an increased interest in customer segmentation initiatives which we refer to as Know Your Customer projects and finally, this segment continues to benefit from the ramp up of new strategic accounts, one in the past year. The remaining 13.4% of our revenue came primarily from other service-oriented industries of communications, entertainment, media and high-tech which grew 9.5% sequentially and 40.4% on a year-over-year basis.

For the quarter, application management represented 50% of revenues and grew 29% year-over-year and 6% sequentially. Application development was 50% of revenues and grew 59% year-over-year and 14% sequentially. The strength in application development was driven in part by the final stages of pent-up demand resulting from clients having underinvested in their businesses during 2008 and 2009 due to the economic uncertainty. During the quarter, 77.7% of revenue came from clients in North America.

Europe was 18.9% of total revenue and 3.4% of revenue came from the Asia Pacific, Middle Eastern and Latin american markets. On a reported basis, Europe grew by 14.7% sequentially and 39.8% year-over-year. During the third quarter, European revenue was positively impacted by approximately $6.4 million compared to the second quarter due to the strengthening of the European currencies in the quarter. On a constant dollar basis, Europe grew 11.6% sequentially.

Pricing on a sequential basis was up 1% on site and flat offshore. We continued to have success in our pricing discussions with our existing client base and expect to see the benefits of these ongoing discussions over the coming quarters as rate increases start to kick in. We had gross additions of 87 new customers during quarter. We closed the quarter with 697 active customers. During the quarter the number of accounts which we considered to be strategic increased by five. This brings the total number of strategic clients to 160. We continue to see a trend towards our newer strategic customers embracing a wider range of Cognizant's services earlier in the relationship.

Turning to costs. On a GAAP basis, cost of revenues exclusive of depreciation and amortization was approximately $700 million for the quarter and included approximately $2.8 million of stock based compensation expense. 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 over 6,400 during the quarter and ended the quarter with over 83,100 technical staff. Third quarter SG&A, including depreciation and amortization expense was $289 million on a GAAP basis and included approximately $11.3 million of stock based compensation. Our GAAP operating margin was 18.8% for the quarter, and our non-GAAP operating margin, which excludes stock-based compensation expense, was 19.9%, within our target range of 19% to 20%.

The average rate for the rupee was 46.4 in the third quarter of 2010 versus 45.5 in the second quarter of 2010 and 48.3 in the third quarter of last year. $165 million of rupee-denominated operating expense cash flow hedges settled during the third quarter. This resulted in an $8.4 million gain, which was recognized in operating expenses. As of September 30, 2010, we have outstanding contracts with a notional value of $165 million, and a weighted average forward rate of INR48.8 to the $1 scheduled to mature in Q4 of 2010. We have $780 million at a rate of INR48 scheduled to mature in 2011, and we have another $780 million at INR48.1 scheduled to mature in 2012, and finally we have $360 million at a rate of INR50.1 for 2013.

We had $7 million of interest income during the quarter. In addition, we had a net gain of $7.9 million of other non-operating expenses, which included $7.6 million of net foreign exchange gains related to balance sheet remeasurements primarily associated with the movement of the dollar versus the rupee, pound and Euro and certain balance sheet hedges. Our GAAP tax rate for the third quarter was 16.3%, slightly below our original expectations, due primarily to the favorable impact of our foreign exchange hedges in Q3 and certain discrete items relating to our ongoing operations recorded in the quarter. We expect the full year 2010 tax rate to be approximately 16.5%. This projected rate for the year does not take into account any future tax impact related to our foreign exchange hedge program.

Turning to the balance sheet. Our balance sheet continues to strengthen and remains very healthy. We finished the quarter with over $1.9 billion of cash and investments, up approximately $277 million from the end of the second quarter. During the third quarter, operating activities generated over $234 million of cash, financing activities generated almost $62 million of cash, comprised of the proceeds of our employee equity programs and related tax benefits, as well as our employee stock purchase plan. We spent approximately $3 million for acquisitions and $45 million for capital expenditures during the quarter.

As previously mentioned for 2010, we expect to spend approximately $180 million in capital expenditures. The substantial majority of which will support another wave of facility expansion as we finish absorbing our last wave of construction. Based on our $1.06 billion balance as of September 30, we finished the quarter with a DSO including unbilled receivables of 80.5 days, up from 77 days in the second quarter. The quality of our receivables portfolio remains very strong; however, we are disappointed in the DSO increase during the quarter, 80 plus days lags the industry and we can do better.

To be clear, this is not a quality of receivables issue, rather due to the strength of demand that we've seen over the past two consecutive quarters and the resulting double digit sequential growth, our client teams have been principally focused on revenue generation and business development. As a result, working with clients to clear payments did not receive its normal level of attention. We have implemented additional processes to refocus our team on DSO and expect that the trend of increasing DSO will reverse in Q4. The unbilled portion of our receivables balance was approximately $146 million at the end of the third quarter.

The growth in our unbilled balance resulted in part from the strong growth in our development services. Approximately 63% of the Q3 unbilled balance was billed in October, compared to 60% of our Q2 balance, which billed in August. During the third quarter 31.2% of our revenue came from fixed bid contracts, essentially flat from the second quarter of 2010. Net headcount increased by close to 7,000 people during the third quarter, of which approximately 53% of the gross additions were hired directly from college and 47% were lateral hires of experienced IT professionals.

We ended the quarter with approximately 95,600 employees globally. Similar to others in the industry, we expected and experienced increased levels of attrition during the third quarter. As we have discussed in the past, there's no consistent methodology in the industry to report attrition numbers. We have historically reported attrition by annualizing the turnover which occurred within the quarter, including both voluntary and involuntary. This number increased sequentially to 21.8%.

Much of the industry calculates turnover on a trailing 12 month basis. Calculated this way our attrition was 18.2% during the quarter. It is also important to note that our attrition statistics include all departures, including BPO and employees in our training program. We believe this pick up in attrition resulted from a rapid return to hiring by many of our competitors. Combined with a catch up, a pent-up demand from those who were considering departing during 2009 and early 2010, but were unable, due to the economy. The attrition was primarily at the junior levels. We remain very focused on addressing this spike in attrition.

We are making it clear to our associates, both in our employee communications, and also in our actions, that Cognizant's strong growth creates tremendous career opportunities for each of them. This includes implementing a record number of promotions, including a promotion round that was completed today. In addition, we continue our efforts on employee engagement, transparent communication, insuring that we continue to foster a collaborative entrepreneurial culture which our associates tell us is the secret sauce at Cognizant, or what we simply refer to as Cognizant DNA.

Finally, we will certainly share the success of this year's performance with our employees through very strong variable compensation pay outs for the year. Based on the attrition data so far this quarter, we expect attrition to decline in Q4 as compared to Q3. During the quarter, we accelerated the hiring of both recent college graduates and experienced professionals. In total, our gross additions were close to 12,000. Offshore utilization was approximately 75% during the quarter. Offshore utilization excluding recent college graduates who were in our training program during the quarter, was approximately 83%. On site utilization was approximately 92% for the quarter. At the end of Q3, we had over 7,100 unbilled people in our training program.

I'd now like to comment on our growth expectations for Q4 and full year 2010. For the fourth quarter of 2010, we are projecting revenue of at least $1.27 billion. Our guidance for the fourth quarter reflects our view that there will be no budget flush this year. For the full year 2010, we continue to expect industry-leading revenue growth, based on current conditions and client indications we've increased our guidance for revenue to at least $4.55 billion. This represents growth of approximately 39%. As previously mentioned during Q3, we met our margin targets, and for the remainder of the year, we expect to operate within our target margin range of 19% to 20%, excluding stock-based compensation expense.

Therefore, we are currently comfortable with our ability to deliver in Q4, GAAP EPS of $0.64 and non-GAAP EPS of $0.68, which excludes estimated stock based compensation expenses of $0.04. This guidance anticipates a Q4 share count of approximately 311.6 million shares and a tax rate for the fourth quarter of 17%. This guidance excludes any non-operating FX gains or losses in the fourth quarter. For full year 2010, based on current business trends, we have increased our GAAP EPS guidance to $2.35, and now expect our full year non-GAAP EPS to be $2.50, excluding $0.15 of estimated stock based compensation expense. This guidance anticipates a full year share count of approximately 309 million shares and a full year tax rate of 16.5%. This guidance excludes any fourth quarter non-operating FX gains or losses. We would now like to open the call for questions. Operator?

(Operator Instructions). Your first question comes from the line of Julio Quinteros with Goldman Sachs.

Good morning. Just real quickly, let me start with a quick question in terms of the risks from the new technologies. We have these debates all the time internally about the types of risks that SaaS and cloud and virtualization could present to the broader SI business. The systems integration, the apps development business, as those things get implemented and installed, what do you guys see as the risks of potentially losing revenue opportunities as those platforms are put into place then, I guess in some sense, people think that ultimately leads to less consulting demand. How do you guys think about that potential risk for your model?

Julio, as you said, there's a lot of philosophical debates on this issue going on right now. If I would summarize it I would say we've gone out there and looked at this and started to actually do work for our clients across the range of technologies, I think that our view is that the nature of demand is different. It's a different wave like when we saw other technology shifts in the past. We have to make sure that we retool ourselves and we are doing that actively for the new generation of technologies that are out there but we think that the same drivers that drove demand for customization and systems integration in the past will continue to be the case with this new breed of technologies. In the end, the new technologies need to be put to work for clients and that requires customization. It requires implementation, it requires systems integration and those things will be done differently but will still need to be done and we think that will drive demand for our services.

Okay, and then just as a quick follow-up for Gordon. Can you just elaborate a little bit on what your thinking is around what the impact is of, I think you made a statement about the final stages of pent-up demand. How are you thinking about what that means and I know we haven't heard or seen the 2011 guidance yet, but just curious on the final stages comment in terms of how you're thinking about how that projects out.

Sure. We originally were expecting the work related to M & A work to ramp down during the third quarter. It didn't, it actually grew a bit in the third quarter, as the projects got extended. We don't expect any further growth in the fourth quarter. We would expect that work to be essentially flat to maybe trailing off in the latter part of the quarter, and then obviously most of it would be wrapped up during by the time we go into Q1. I don't expect it to have any material impact on our overall 2011 growth but as more comments related to, it was a positive surprise in Q3 and we would not expect that to continue in Q4.

Great. Thanks guys. Good luck.

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

Thanks, good morning guys. Just a demand and a supply question if I could please. On the demand side, just wanted to get a qualitative sense of how you feel about Cognizant's prospects for revenue growth over the next 12 months versus how you felt a quarter ago. There's obviously still some macro cross currents out there, which you guys acknowledge but offshore spending in a big picture sense seems to be accelerating and you seem to continue taking share so any qualitative commentary there would be great and then I have a quick follow-up.

Sure. Let me give you some demand color. As we go into the fourth quarter here, obviously we're out with our clients talking to them about their plans for 2011. At this point, very early in our clients' budget cycles but the early indications that we have are that 2011 budgets, IT budgets will have somewhat of an upward bias as you go into 2011 so that's an overall positive sign and as you mentioned we continue to see the trend that clients as I mentioned during my comments, clients are outsourcing more the range of services that clients are now comfortable moving into a global delivery into an offshore model and outsourced model has increased considerably, and we feel like we've made a lot of the investments over the last two or three years to position us well to capture that, so we expect to benefit from that trend.

Okay, and then just on the supply side are you guys seeing any concerning amount of shortage in terms of supply for certain skill sets in the current environment?

Clearly, the demand for talent has increased significantly over the last three quarters and you've seen that in the attrition rates in the industry; however with the exception of what I would point to as what niche skills or particular pockets of technology expertise that you always have flash points around, we don't see overall macro concerns as the supply of talent from the University is still extraordinarily good in India and if anything, we are better positioned than we've ever been in the past in terms of our positioning on the campuses in India because of our strong track record of hiring throughout the crisis. That played very well for us on the campuses, and I think we are very much regarded even more so if that's possible as an employer of choice with the campuses in India so we feel very optimistic about that source of talent.

And just to follow-up that's a very important point. We have our best track record or highest level of day one slots that we've had in our history this recruiting cycle and we think that's a direct result of the industry-leading growth that we have and therefor our ability to promote a higher percentage of our employees so college students see they can grow their careers faster with us and therefor we're getting very preferential treatment in recruiting.

Great to hear. Well nice job guys.

Thank you.

Your next question comes from the line of Bryan Keane with Credit Suisse.

Yes, hi, good morning. I just wanted to follow-up on discretionary spend. Looking at the development revenues obviously sequentially its grown quite strong. Can you just talk about kind of what you're seeing from clients in discretionary areas and do you think that should continue and especially any comments on Financial Services in particular?

Yes, as I said during my comments, our hypothesis has been for some time now that some of the discretionary spending was driven by the structural changes that we see industries going through, and we feel very confident now after having watched this trend for three or four quarters, that that is in fact the case. Clients are really dealing with these three big forces. There's a whole new generation of technologies that are out there that are creating new opportunities for them that are changing the price performance curve of technology.

There's a new generation of workers and consumers, this--the Millennial generation that are really demanding a different technology experience than a year or two or three ago, and finally, there's this new generation of highly distributed and globalized business models that clients are beginning to adopt and feel very comfortable with. All of this is driving new development application development, systems integration, what you might think of as the more discretionary side of our business an we think those are long term trends across the industries that we serve.

Specifically in Financial Services, I think that as growth returns to that industry and more stability returns, what we're seeing is demand that's driven by some of these Future of Work concepts, so when you think about new generation of consumers that are demanding more integrated online banking experiences, a better more robust mobile banking experience and so on and so forth you're starting to see that kind of demand and then of course there's a lot of technology deployment that's being driven in Financial Services as a result of the regulatory initiatives, FIN Reg and so on and so forth, that's requiring Financial Services institutions to put in new technology around Risk Management and so on and so forth to be able to address the regulatory compliance issues here in the US and also internationally.

Helpful. Just one follow-up. Just on pricing, Gordon, you talked about pricing being up 1% on site and flat offshore but it sounds like the momentum on pricing is pretty positive. Can you just talk about what pricing might do in the coming quarters?

Yes, we're feeling good about the conversations that we're having with our clients. As you know, we've been out talking to clients for a couple quarters now. We continue to talk to them, and clients understand that costs are going up, that we help them out during the economic downturn but price increases is needed for either late this year or 2011. These are not going to be huge price increases, but it's clearly moving in the right direction. What ultimate impact it will have on 2011 is a little too early to know but certainly I would expect on an apples-to-apples basis, our pricing to be up and then it's a question of what happens with the mix shift.

Okay, great. Congratulations.

Thank you.

Your next question comes from the line of Darrin Peller with Barclays Capital.

Thanks. Margins have been at least at the high end of the target range for some time now, and I'm curious, would you say your target range is maybe closer to 19.5% to 20% at this point or has there really just been pent-up demand that's sustaining margins higher than a more normalized level?

Obviously, revenue has been very strong for the last couple quarters and we've exceeded our expectations and certainly as revenue comes in strong later in the quarter we can't spend all the money. We continue to focus on a 19% TO 20% range, obviously for a while we've been running at the high end of that range but so we don't have any plans to narrow it.

Okay, and then just a quick follow-up. Can you quantify a little more on wage inflation. Just what exactly did you see this quarteR? What do you expect over the next couple quarters and is pricing you disclosed enough to offset any type of wage inflation changes?

Sure. We did our wage increases in the first half of the year and other than obviously we do people get promoted in the fourth quarter get a salary increase but besides that there is no additional wage increases, so we went, we had a one-time cycle this year which I believe pretty much everyone else in the industry has done and I think people have largely been fairly disciplined on wage inflation.

Certainly it was up from 2009. We would expect to do our next wage increase during the second quarter of 2011 so we expect to continue on an annual cycle. A little too early to know how big it will be next year and a lot of that will depend on what the competition does and to date the competition has been very disciplined in wages, because I think everyone understands that it's not possible to gain competitive advantage on wages.

Great. Thanks, guys.

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

Hi guys. It's a little bit premature but I'll throw the question out there. Just looking at 2011 any way you can quantify what you're hearing from clients as far as budgets being set and as far as any potential increase in those budgets and do you expect the wallet share of offshoring to kind of increase heading into that year?

Joe, It's Frank. Look, I think that it's still early in the budget cycle. Let me say a couple of things about budgets. First of all, this year we're seeing the timing of budgets has gone back to being what I would call a more normal cycle, so we expect that our clients will finalize budgets as they have in more normal times at the latest during the middle of the first quarter of next year, so with that schedule in mind, it's important to know that we're still relatively early in most clients budget cycles, but based on what we've seen so far and the early conversations we're having as Gordon pointed out earlier, we do think that budgets for next year will have, the indications are that budgets are poised for a slight increase next year. Hard to say exactly how much that increase is at this point but we do think budgets will be up, IT budgets will be up next year over 2010 levels.

Within that though, I think that the trend of offshore in general or outsourcing more broadly will have a greater share of that, I think is definitely the case. We are seeing clients pushing the envelope on the traditional services in terms of looking at areas of even application, outsourcing or application development that they may not have traditionally outsourced but then there's this whole new set of services; IT infrastructure services, business processes outsourcing, engineering and manufacturing services, enterprise analytics that historically three or four years ago or two or three years ago even clients would not have considered outsourcing or offshoring. Those are now viable candidates so I think that you'll see the trend to offshoring capturing a greater share of the IT wallet and the IT budget continuing strongly.

So just excluding maybe the M & A ramp, which is going to make its way through the numbers, are you more positive about heading into 2011 than you were heading into 2010, is the environment looking better than it was a year ago?

Clearly the environment is more stable and I think a more stable environment allows us to plan better. I think IT budgets are looking like they have a positive buy which I would not have said at this time in 2009 coming into 2010.

Okay, just real quickly on the attrition side, and my last question, when can we expect that number to go down and when do you start to get overly concerned about it? Maybe you can just give us a little more color how you're looking at it because I know you commented about getting more day one slots.

I would expect it to come down this quarter, from Q3 levels. The trend has been positive in October versus what we saw in the earlier part of the second quarter, so our expectation is that starts to come down, it won't come back down to normal though in the fourth quarter. I think that will-- to get back to a more normal level, the college kids not just for us but for the industry have to, more of them have to be on-boarded and trained. They are all being on-boarded now which means they become available for billing first, second quarter of next year.

Okay, thank you.

Your next question comes from the line of Ashwin Shirvaikar with Citi.

My first question is as you look at your average client's uptake of your services, is it possible to quantify the forward-looking potential? Can this client be 2X or 3X the current size in the next let's say five years in terms of picking up some of these new offerings that you have?

Ashwin, you're hitting on a fair key point. Our addressable market, within most of our customers has expanded dramatically over the last couple years as we've expanded our range of services whether it be into BPO or infrastructure management or consulting or testing or ERP, so the addressable market at each client is bigger and therefore, what has happened even as we've grown our relationships, the penetration rate at those specific accounts has not grown at the same pace, because the market at that account is getting bigger, so we actually feel very good about the opportunity that still exists at the vast majority of our clients, simply due to the fact there are more things, more wider range of services that we can offer to them.

Okay, and a couple of nearer term questions. One is your comment on no fourth quarter budget flush. Is that what clients are telling you or is that sort of the net result of Q4 seasonal demand being offset by some M & A drop off? And then last question would be on is the faster than anticipated growth, will that help your 2011 tax rate?

Ashwin, let me do the first part of the question and I'll turn it to Gordon on the tax rate question. Look, the pent-up demand question is there isn't a scientific way around this. This is based on our conversations with clients and our own intuition about what's going on in the marketplace. The reality was that we saw quite a considerable, as you know, very strong Q2 and Q3 spending from our clients and our sense right now is that there isn't a lot of -- budget flush tends to happen when clients have a little bit of extra money at the end of the year in their budgets and they want to get it used in the fiscal and the calendar year. Given the strong spending we saw in Q2 and Q3, I don't think that there's a lot of extra money out there that clients are going to spend in Q4, so based on that and conversations with clients we don't think there's a lot of pent-up or rather budget flush that's waiting to happen at the end of the quarter.

Ashwin, on the tax rate you're correct that the stronger growth this year which obviously is the base for growth for next year helps our tax rate for 2011; however in the last couple months the Indian government has made it clear that the reduction in the actual tax rate in India won't happen until 2012 so those two things kind of offset each other and at this point we're still expecting a tax rate due to the expiration of the holidays in 2011 of somewhere between 23% and 25% and at this point I think most people are modeling the high end of that range and I think that's probably appropriate.

Thank you guys. Great quarter.

Your next question comes from the line of Mayank Tandon with Signal Hill Capital.

Francisco you mentioned about regulatory opportunities. Could you give us some sense of timing in terms of when the impact will actually happen, does it happened today as we speak or is this more of an FY 2011 scenario and also maybe size it for us in terms of what the opportunity could be relative to other opportunities that you've had in the past.

Yes, look, I think that we are already benefiting to some extent from the regulatory work. If you look at some of the near term stuff that we've talked about in healthcare for example,, Gordon mentioned ICD-10, 50/10 remediation and so on, those projects are under way generating revenue and have been a part of our healthcare growth story over the last few quarters, so some of that's already under way. As it relates to the broader issues of financial regulatory reform, Basel III, internationally and the big healthcare reform in the United States, I think those will drive 2011 opportunities for us. Sizing it is still too early for me to give you a good sense of that for 2011 and longer term because I think that, how these unfold and how much of it we can capture still remains to be seen but clearly, we'll generate 2011 opportunities for us.

Will it be a big burst in spending or is it really more of a step function and also if you could comment on how does this get funded? Does it come away from maybe certain areas where you would have had spending but this is taking share from that so net-net it's probably more neutral in terms of driving incremental growth.

I don't think you're going to see big surges in spending for one-time or for a short period of time and then tapering off. I think that these are longer term initiatives. Clients are taking steps in terms of implementation. There are some deadlines out there or will be some deadlines out there which may drive spending patterns but in general our view right now is that these are going to be more incremental spending over 2011 and 2012.

In terms of how they are going to be funded I think there's going to be a mix. I think some of it clearly will cannibalize dollars that clients would otherwise have spent on other things, so the business as usual dollars or the maintenance dollars might move more towards regulatory related enhancements and fixes but I think that there's some amount of work that needs to be done particularly the work that's needed to drive new capabilities that will require incremental funding. We think that that's actually a great opportunity for us because what we see is that in crunch situations, what clients are doing is outsourcing more of their business as usual initiatives to use the savings that they generate from offshoring and outsourcing to fund the investment that they need in new capabilities and in regulatory enhancements so we think that overall, that's going to be a positive for us because it will drive more work offshore to be able to fund the investments that clients need to make in these new capabilities.

That's helpful, and Gordon if I can just ask you on pricing one more time. Is this truly apples-to-apples rate increases or is it really more a question of the mix of services that's driving pricing increments?

In terms of getting price increases we're getting price increases on apples-to-apples basis. How that flows through the numbers obviously gets impacted by the mix so the 1% up on site flat offshore, that includes mixed but there wasn't a whole lot of mixed impact this quarter, but so that's why it's tough for me to say what will happen with pricing next year, including mix but excluding mix, clearly we're getting price increases.

Great. Thanks guys.

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

Hi, good morning. Was the attrition and maybe the tightness in the labor market impact your ability to grow even faster than you did this quarter?

Look, I think, Ed, there is certainly some of that. We had utilization ran very very high in the third quarter, it was up from the second quarter and so we started to hire even more aggressively and our goal is attrition, excuse me, utilization will bounce around over the coming quarters but when our goal is to bring it down a little bit at this point so clearly tightness in the labor market, more importantly our ability to hire and on Board. We measure that carefully so that we make sure that we're not compromising on quality of what we deliver to clients and that's always a tradeoff that we're going to make.

My other question is on your Crystal ball as far as what's going on in Washington, we understand no matter what happens with Senator Reid, Senator Schumer is not a big fan of offshoring global delivery will take a bigger role in the Senate. Maybe you can give some thoughts on what you're hearing and what implications there might be for the firm.

You're right. I don't have a crystal ball but I guess by tomorrow we won't need a crystal ball so we'll know what's happening at least in terms of the midterm elections, but look, we're on the eve of President Obama's trip to India and I think that there's been some statements in some briefings out of the White House which have in preparation for his trip which I think have put the issue in perspective. I think the India/US relationship is a very strong bilateral relationship of which outsourcing is one piece but as you may know, exports of US products into India have grown dramatically over the last few years. I think now accounting for something like $27 billion to $30 billion a year.

I think that Indian companies in the United States account for employment of about 60,000 people in the United States and so I think that there's a broad recognition that the India/US relationship needs to be a strong bilateral one based on trade going in both directions. I think that's going to be a big part of the discussion that happens when President Obama visits India in a few days here and I think that's the context in which we believe the outsourcing discussion needs to be had, which is flow of goods and services in both directions.

Thank you.

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

Thanks for taking my question. First real quick, I was wondering if you are seeing difference in demand trends either for Q4 or more importantly for next year on what you're hearing for budgets between US and Europe?

Obviously, the US economy stabilized before Europe, so we saw the pick up in the US kick in first. UK seems to be doing okay now. Still keeping an eye on the continent, so a little bit too early to declare a victory there so if I think about Q4, I would kind of rank my enthusiasm in that order.

Okay, and then on the solution side of things you highlighted a couple in your prepared comments. Is there any way to quantify what percentage of revenue is tied to those types of solutions and where you think that can go and then do you look at that area as kind of the primary area of focus for M & A?

Let me talk about M & A. Our view with M & A is that we for a while we've said that our approach, let me start with our approach. Our approach to M & A is to look at small tuck under acquisitions that add capability in specific areas. For us, when we think about the size of Cognizant today and we think about what a tuck-under acquisition means, our sweet spot really is probably in the $20 million to $80 million range maybe going up as big as $200 million in revenue but really $20 million to $80 million is our sweet spot of revenue for an acquisition.

We like that size of acquisition because we feel it's easier to get our arms around, cultural integration is easier with those kinds of acquisitions. When it starts to get larger than that, then the risks of those acquisitions become more significant, and frankly at this point we're looking to add capabilities. We're not looking to acquire for growth.

When we think about the kinds of capabilities that we're looking to add certainly the emerging service offerings is a key area so IT infrastructure services, vertical business process outsourcing, and then the new ones like EMS and analytics, and EMS is engineering and manufacturing services or analytics would be areas that we look at. We also would be looking at acquisitions from a geographical expansion standpoint, so we did the acquisition of Galileo some time, a couple quarters ago in France. We'll do those kind of acquisitions that give us specific geographic capabilities and footprints and then potentially look at acquisitions that deepen or broaden our industry footprints so that's really our screen and how we're looking at.

In terms of the emerging services your first question and the percent of revenue, we haven't actually broken those out in the past but clearly, if you look at those as a portfolio of services those are growing ahead of, in general, ahead of Company average and we expect that those will continue to do so over the coming quarters although some of that is because they are off a smaller base at this point.

Okay, great and last question, Gordon, on utilization, if you do see attrition come down, you guys have obviously run utilization higher than historical norms, do you think that utilization rate we've seen will start to decline a little bit as attrition slows down and you continue to hire?

It's going to bounce around a bit from quarter to quarter. Would I like it on average to come down slightly, yes, slightly, I don't think it needs to come down dramatically, but what (inaudible) we're somewhere in the range now so it will bounce around but if I was betting I'd try to get down a little bit.

Okay, great. Thanks for taking my questions .

Your next question comes from the line of Joseph Vafi with Jefferies & Company.

Hi guys good morning. One quick question here. Most everything has been asked but anything we should read into the large percentage of lateral hires in the quarter relative to shorter term demand and deploying those already trained people versus what maybe we would see in a more normal environment?

Joe, the point you're hitting on was a big issue for us in the first half of the year where we were very heavy percentage of lateral hire and just because the demand came back so quickly. We're starting to catch up now so this is the first quarter in a while that college hiring actually exceeded lateral hirings and I think this is an industry wide issue and as we get a couple quarters under our belt of a lot of college kids coming in that should help the attrition issues so the trend clearly went in the right way which is shifting back towards college hiring. It just took us a couple quarters to get there because revenue growth was so strong.

Just one other quick follow-up. If pent-up demand kind of does indeed end here and under the thesis that a lot of the pent-up demand was fulfilled with on site versus offshore or a higher on site mix, would we expect to see maybe a mix shift more towards offshore next year or even the number of people on site kind of go down a little bit at some of your clients?

I don't think that the pent-up demand was fulfilled by services or for any reason had a higher on site component. I think it was right in line with our traditional delivery model so I don't think the pent-up demand somehow drove on site ratios up. I don't see anything that will change the mixed-- the ratio on site offshore significantly next year except mix shift. As you know, some of our service offerings have much higher offshore components like BPO and IT infrastructure services so to the extent those become a larger portion of revenue next year that might shift the overall Company mix more offshore but beyond that, I don't see anything else moving the mix dramatically.

Thank you.

Thanks, I think we have time for one more question Operator?

Your last question comes from the line of Rod Bourgeois with Bernstein.

Yes, guys, just wanted to ask a question on the demand front real quick. Gordon, I guess I'm wondering whether you're feeling at all a need to temper expectations on The Street at all and since this is at almost 24% revenue growth for 2011 and likely to come up some more after today. It sounds from your report like demand drivers are very much in place for a strong 2011 and your guidance for December certainly looks solid, but it's also unclear that discretionary spending in 2011 will be as strong as it is in 2010. So I guess overall are you feeling okay about where consensus estimates are at this point as we head into the 2011 time frame?

So let me hit two things on that question. First of all in Q4. The pent-up demand being finished, that was important because it was a big driver in Q2 and Q3 sequentially, and we don't view that as a driver in Q4 so we wanted to keep people's expectations for Q4 sequential growth in check. A little too early to know for 2011.

Until clients finish their budget cycle, we understand what regulatory--what impact will the regulatory changes have. Obviously, we won't benefit in 2011 the way we did in the first half or first three quarters of 2010, of the same level of surge in development spending from pent-up demand but obviously there's some other important growth drivers out there but we just have to get a little further in the budget cycle to have a view on 2011 but for Q4 of 2010 obviously that pent-up demand is finished.

Is part of your comment about Q4 lacking as much in the pent-up demand category? Is part of that a function of the M & A sort of ramp down activity that you're seeing and if so, can you give us some numerical idea of how big the M & A ramp down might be? How many millions of dollars of projects is the M & A ramp down worth?

For Q4 I would think about the M & A more as you're not going to see growth, in Q3 we still have substantial growth in M & A, where we're not expecting that. It's clear we won't have that growth in Q4, but the important point in Q4 is we certainly don't expect the same level of new project kickoffs on development work that we experienced for the last couple quarters. All that being said, demand is still healthy, but there's some surges that we would not expect to reoccur in Q4.

Gordon, part of that lack of new project kickoffs that's partly just a function of Q4 where things often slip into January with new budgets. Is that, so some of that is seasonality or is it more than just normal seasonality in terms of project kickoff being not quite as strong as in the last two quarters?

I think it's a little bit of each. There's no budget flush this year and you're absolutely right. We tend not to have a lot of kickoffs in Q4 or the first month of Q1 until people lock down their budget.

Okay, I think we're a couple minutes over here so I just want to thank everyone for allowing us to share our Q3 results. We're confident that we're positioned to address the many changes in the marketplace that will drive our future growth and we look forward to continuing discussion of our performance with you next quarter so once again thank you all very much for joining us this morning.

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