高知特 (CTSH) 2013 Q2 法說會逐字稿

Ladies and gentlemen, welcome to the Cognizant Technology Solutions second-quarter 2013 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 Treasurer at Cognizant. Please go ahead, sir.

Thank you, Operator. And good morning, everyone.

By now you should have received a copy of the earnings release for the Company's second-quarter 2013 results. If you have not, a copy is available on our Website at Cognizant.com. The speakers we have for today's call are Francisco D'Souza, Chief Executive Officer; Gordon Coburn, President; and Karen McLoughlin, Chief Financial Officer.

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. Francisco, please go ahead.

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

Cognizant's second-quarter performance was strong and ahead of our guidance for the quarter. Second-quarter revenue was $2.16 billion, a sequential increase of 7%, and an increase of 20.4% year-over-year. Our non-GAAP operating margin was above the top end of our target range at 21.4% for the quarter. This was primarily due to the weakness of the Indian rupee, the timing of wage increases in the year and higher utilizations. Based on our strong growth this quarter, and our expectation of continued healthy demand environment for the rest of the year, we have increased full-year revenue guidance by $140 million, to $8.74 billion, which represents at least 19% year-over-year growth.

I'm pleased with our strong growth this quarter. We added more incremental revenue this quarter than all but one other quarter in our history. I would like to comment on some of the drivers of this quarter's performance before I turn the call over to Gordon and Karen for the operating and financial details.

During the quarter, we celebrated the 15th anniversary of Cognizant's IPO on the NASDAQ stock exchange. While much has changed at Cognizant during that time, one thing that remained absolutely consistent is our strategy of reinvestment in the business to drive top line growth. During the 15 years, we have maintained stable operating margins, and delivered industry-leading revenue growth. In recent years, we have focused our investment across three growth horizons. We implemented the three horizon approach in response to a fundamental long-term shift we identified in our client's business imperatives. We think of these imperatives in terms of a dual mandate. Run better and run different. As a reminder, run better is where we have clients drive greater performance in their current business, and run different is where we help clients improve the positioning of their businesses for future success.

On our call last quarter, I went into some details outlining our Horizon 3 portfolio. I spoke to you about our progress in building out our capabilities in the SMAC technologies; social, mobile, analytics and cloud. We continue to see strong evidence that SMAC is the next secular shift in computing and we're investing accordingly. And we've had some great client wins across our SMAC practices. For instance, we recently engaged with a global consumer goods company to build a center of excellence for social media analytics, which will enable them to derive actionable insights from the data delivered from a variety of social media sources. As enterprises around the world focus on digital transformation of their operations, and SMAC becomes ever more prevalent in the industry nomenclature, we are seeing that our early lead and our spot leadership in this area gives us a distinct competitive advantage in the market.

And while I'm pleased with the investments we have made in SMAC as a driver of growth, I am also pleased with the healthy growth in our Horizon 1 and Horizon 2 services, which Gordon will talk about shortly. The growth in these services is important because it demonstrates our continued success in enabling clients who have to increase -- who have to increasingly run better in order to free up investment for run different initiatives. I'm confident that Cognizant has world class offerings on both dimensions of the dual mandate.

As we look to the remainder of the year, we see a continuation of the healthy demand environment for our services, which gives us the confidence to raise guidance for the full year. The demand comes from us from a combination of macro trends and our own competitive positioning. On the macro front, in North America, our largest geographic market, as consumer and business confidence continued to show modest improvements, our clients are starting to turn their attention to making investments in software and services. Often these investments are funded through modest budget increases but more often the funding comes from driving efficiencies in other parts of the business. And in Europe, which represents the majority of the remainder of our business, as the macro environment in many countries continues to be challenging, we are finding an increased appetite from clients to move more work to a global delivery model.

Let me end my remarks by saying that I think our strong performance is a testament to the strategy we have been implementing and discussing with you in recent quarters. I believe that we are extremely well positioned and I'm encouraged about our prospects for the remainder of the year.

Now I will hand it over to Gordon to share more about our performance and to Karen to provide more financial details. I will return to the conversation for Q&A. Gordon?

Thank you, Francisco.

We had another solid quarter with demand across our industries, geographies and service lines generally playing out better than anticipated, driven in part by strong discretionary spend. Our Horizon 1 services performed very well with particular strength in consulting and technology services. This is in line with what we see in a normal budget and spend cycle where we see the full quarter impact of the current year's budgeted discretionary spend kick in during the second quarter.

The strong growth in our Horizon 1 services is a further validation of our balanced approach to growing and integrating our core services with our emerging services and new service offerings. For example, we saw this reflected in the performance of our quality engineering and assurance practice, which performed exceptionally well this past quarter. Today, this practice has over 20,000 career testers providing a wide range of testing services across all three horizons of our business, including in newer and rapidly growing areas such as testing for regulatory compliance, testing of mobile applications, product testing, and testing consulting and advisory services. As a market leader in this service offering, we are seeing strong interest by clients in utilizing our testing services and IP, through newer business models, such as managed services.

Turning to Horizon 2 offerings, on a combined basis, our Horizon 2 services continued to grow faster than Company average, driving both mind share and market share. Cognizant business consulting, or CBC, continues to lead the charge for many of the transformational deals we win. During the quarter, several key wins were a result of CBC being an integral part of our pursuit in helping us present a transformational road map to our clients. It is important to note that these consulting-led transformational deals cut across our Horizon 1, Horizon 2 and Horizon 3 businesses.

Our vertically aligned BPO practice continues to show solid growth, supported by expansion of work with existing clients and recent wins with new clients. With every passing quarter, we continue to expand our capabilities in vertically aligned BPO. This quarter, for example, we saw some good wins around provider credentialing, health exchanges, asset management, and banking reconciliation. Additionally, we continue to expand and strengthen our US delivery and operations capabilities to support our BPO services. As part of this effort, we recently completed a tuck-under acquisition of SourceNet Solutions, an accounts payable service provider located in College Station, Texas, which was owned by our long time financial services client BNY Mellon. This acquisition brings SourceNet's processing platform to Cognizant.

IT infrastructure services continued to see robust growth across industries and geographies. As indicated in the previous quarter, we continue to see more deals integrating applications and infrastructure, and delivering significant value to clients from their synergies. During the quarter, we won several large deals, some of them being end to end, multi-year IT infrastructure deals that included data center migration, provisioning and support leveraging our recently-added data centers. One good example is the deal with Orkla, the Nordic's leading supplier of branded consumer goods. Under a five-year agreement, Cognizant will provide a broad range of applications and end to end infrastructure management services to Orkla, delivering a more stable and scalable technology environment, improving service quality, predictability, flexibility and business agility.

Looking at our performance from an industry standpoint, financial services continued to perform well during the second quarter, growing over 6% sequentially, and 24% year-over-year. Within banking, among both our larger and mid-sized clients, demand continues to be driven by ongoing cost optimization, a steady pick-up in regulatory and risk management projects, and the growing importance of mobility and analytics.

Healthcare, which consists primarily of our payer and pharmaceutical clients, grew 6% sequentially and about 12% year-over-year. While we expect the growth of our pharmaceutical business to remain slower than Company average, given the industry's ongoing challenges with patent expirations, the work with our payer clients is beginning to rebound. The growth in the payer sector is broad-based among many of our larger clients. In particular, we are executing a number of consulting, program management, IT and BPO assignments, assisting clients with participation in the new health insurance exchanges.

Our retail manufacturing sector, which had another strong quarter, growing 8% sequentially, and 29% year-over-year. Within retail, the strength of our consulting and program management capabilities, coupled with our deep industry knowledge, is enabling us to win a number of strategic deals. During the quarter, we were selected to implement a supply chain initiative for a major retailer and we continue to expand the number of clients that we serve as their e-commerce partner.

Our other segment grew 8% sequentially and 15% year-over-year. Within the telecom portion of this segment we saw a broad-based growth and project ramps across a number of our key accounts. We also saw strong sequential growth in the high-tech portion of this segment, resulting from strong discretionary spend, as this area is more heavily weighted towards development work.

Moving on to our performance by geography, North America grew 6% sequentially, and 17% year-over-year. Europe saw healthy growth at 11% sequential and 37% year-over-year. Breaking down the European performance, UK grew 8% sequentially and 28% year-over-year. Including the impact of the C1 Group acquisition, Continental Europe grew almost 16% sequentially, and 54% year-over-year. Excluding the revenue from the C1 Group, growth in Continental Europe was approximately 6% sequentially.

Last quarter, we spoke to you about the acquisition of the six companies of the C1 Group with strong presence in Germany. Integration is progressing well. We are jointly going to market with a broader and deeper set of capabilities, and stronger local presence. Within a short period of time, since we closed this acquisition at the start of March, we have jointly won several new logos, and have expanded our capabilities with existing customers in Germany and Switzerland. As discussed earlier, we are seeing a structural shift to long term outsourcing deals across Europe with the economic climate serving as the catalyst. Because of our continued investments in Europe, local leadership, and broad range of capabilities, we remain optimistic in our long-term growth prospects across Europe.

Our growth in the rest of the world continued to remain strong, growing 7% sequentially, and 25% year-over-year, as our investments in key markets such as Singapore, India, and the Middle East, are continuing to drive accelerated growth.

I would now like to quickly touch base on the status of immigration reform. As many of you know, and as expected, a comprehensive immigration reform bill was passed by the Senate in late June. Our view of the bill remains unchanged. The bill includes some very good things for the American economy, our customers, and our industry. But also includes several clauses which, if enacted, would be detrimental to our clients and US competitiveness. Now that the Senate has passed this bill, the immigration debate shifts to the House of Representatives.

The House leadership has clearly stated that it does not intends to consider the Senate's bill. Rather, it will follow a different approach and develop its own legislation through a step by step approach. It is unclear whether the approach in the House will result in a bill as comprehensive as the Senate's or several separate bills addressing targeted components of immigration. In late June, a high-skilled immigration bill was passed by the House Judiciary Committee. This proposal includes many of the positive components of the Senate bill, such as increasing visa caps and streamlining the green card process. However, it did not include the onerous out-placement clause found in the Senate's bill. It is clear that we are still in the early days of the House's discussion of immigration.

In addition, we were pleased to see the Indian government raise the potential impact of the Senate's H1B provisions on the US-India relationship, and the India government's understanding of the concerns of the US government and US technology companies regarding certain of its policies, and the flexibility that the Indian government has shown on these issues. On the client side, we are seeing no change in client behavior as a result of the immigration debate. We are discussing the issue with clients and other stakeholders who are interested, though such requests have been few and far between.

Finally, let me comment on our attrition during the second quarter. Annualized attrition was 18.7%. We calculate attrition by annualizing the turnover which occurred within the quarter, including both voluntary and involuntary. Our attrition statistics include all departures, including BPO, and employees in our training program. Although we often see a sequential increase in attrition during the second quarter, this year's increase was a bit higher than normal.

Our attrition was heavily weighted towards our junior staff offshore, and it was impacted by the timing of our 2012 bonus payments, as well as the completion of our 2012 performance evaluation process. Although attrition increase was not entirely unexpected, we are certainly paying attention to this uptick. In addition to the compensation increases and promotions that took effect July 1, we are also are making it very 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.

I will now hand the call over to Karen to comment on our financial performance and guidance.

Thank you, Gordon. And good morning to everyone.

As detailed in our press release, our second-quarter revenue grew 7% sequentially and 20.4% over last year's $2.16 billion, ahead of our guidance of $2.13 billion from last quarter. Our non-GAAP operating margin, which excludes stock-based compensation expense and acquisition-related expenses, was 21.4%, above our target range of 19% to 20%, while our GAAP operating margin was 19.7% for the quarter. We generated $1.07 of non-GAAP EPS and $0.99 of GAAP EPS for the quarter. Both GAAP and non-GAAP EPS included $0.07 of non-operating FX losses for the quarter.

As Frank mentioned, the over performance in non-GAAP operating margin was primarily the result of increased utilization during the quarter, the impact of the rupee depreciation net of our hedge losses, and the timing of compensation increases and promotions which took effect on July 1. Our GAAP tax rate for the second quarter was 28.5%. Our tax rate for the quarter and expected rate for the full year is higher than our previous guidance due to primarily to additional tax expense in India related to the impact of foreign exchange movements on certain US denominated assets of our Indian subsidiaries.

Now turning to some of our other performance measures. Consulting and technology services, formally known as application development, represented 50.5% of revenue, and outsourcing services, formally known as application management, was 49.5% for the quarter. Consulting and technology services grew 17.8% year-over-year, and 8.7% sequentially. Outsourcing services grew 23.1% year-over-year, and 5.3% sequentially. 32.4% of our revenue came from fixed price contracts during the second quarter, and grew by 5.4% sequentially, and 16.9% year-over-year. As expected, on a sequential basis, our pricing was stable during the second quarter.

We closed the quarter with 1,100 active customers, and the number of accounts which we consider to be strategic increased by 8. This brings our total number of strategic clients to 229. We continue to see a trend towards our newer strategic customers, embracing a wider range of Cognizant services at an earlier stage in the relationship. Our fully diluted share count for the quarter was 304.4 million shares, a decrease of approximately 730,000 shares from Q1. During the second quarter, we repurchased approximately 1.83 million shares at an average price of $62.94, for a total cost of approximately $115 million. To date, 15.7 million shares at a cost of $998 million have been repurchased under the current share repurchase authorization of $1.5 billion.

Turning to the balance sheet, our balance sheet remains very healthy. We finished the second quarter with approximately $2.9 billion of cash and short-term investments, up by approximately $156 million from March 31. During the second quarter, operating activities generated approximately $365.6 million of cash. Financing activities consumed approximately $106.3 million of cash. This was comprised of expenditures of $115 million towards our share repurchase program, offset by net proceeds of $8.9 million related to option exercises and related tax benefits, as well as our employee stock purchase program. We spent approximately $50.3 million for capital expenditures during the quarter. And during 2013, we continue to expect our capital expenditures to total approximately $400 million.

Based on our $1.79 billion receivable balance on June 30, we finished the quarter with a DSO, including unbilled receivables, of 75 days, down by 1 day from the first quarter. The unbilled portion of our receivables balance was approximately $224 million, up from $206 million at the end of Q1. Approximately 63% of the Q2 unbilled balance was billed in July. Net headcount increased by approximately 1,600 people during the quarter. 48% of gross additions for the quarter were direct college hires, while 52% were lateral hires of experienced professionals. We ended the quarter with approximately 164,300 employees globally, of which approximately 152,700 were service delivery staff.

Utilization increased on a sequential basis during Q2. Offshore utilization was approximately 70%. Offshore utilization excluding recent college graduates who were in our training program was approximately 75%. And on-site utilization increased to approximately 93% during the quarter.

I would now like to comment on our growth expectations for the third quarter of 2013 as well as the full year. For the third quarter of 2013, we are projecting revenue of at least $2.25 billion. For the full-year 2013, we expect to continue delivering industry-leading revenue growth. Based on current conditions and client indications, we are pleased to revise our revenue guidance upwards to at least $8.74 billion. This represents full-year growth of at least 19%. This guidance includes $10 million of expected revenue from the recently-closed tuck-under acquisition of SourceNet Solutions.

During Q3 and for the full year 2013, we expect to operate within our target non-GAAP operating margin range of 19% to 20%. Therefore, we are currently comfortable with our ability to deliver in Q3, non-GAAP EPS of $1.09, which translates to GAAP EPS of $1.00. This guidance anticipates the Q3 share count of approximately 305 million shares, and a tax rate of approximately 27%. Our guidance excludes any non-operating FX gains or losses. For the full-year 2013, we expect our non-GAAP EPS to be at least $4.32, excluding estimated stock-based compensation expense of $0.31, and acquisition-related expenses of $0.05, our GAAP EPS will be at least $3.96. This guidance anticipates a full-year share count of approximately 305 million shares and a tax rate of approximately 27%. It also excludes any further non-operating FX gains or losses.

Now we would like to open the call for questions. Operator?

We will now be conducting a question-and-answer session.

(Operator Instructions.)

Brian Keane, Deutsche blank.

Hi, guys. Just real quick question. Normally 2Q and 3Q sequential growth are pretty similar in terms of revenue but it looks like even backing out the SourceNet acquisition, you're expecting a softer sequential revenue growth from the spike of it looks like about 6% organic in 2Q. Just anything behind that? Or is that just conservatism? And just related to that, the headcount growth wasn't as high as we expected sequentially. Should we expect it to spike back up in headcount growth? And was that impacted by the attrition rate? Thanks so much.

Hey, Brian. It is Gordon. Q2 generally should be our strongest quarter sequentially and the reason why is Q1 tends to be muted, because you don't get a whole lot of discretionary spend in the first half of the quarter. So in Q2 you get the full quarter impact of the new budget cycle and then obviously that continues in Q3 but you don't get as big of a sequential boost. And that is more pronounced in the years where discretionary spending is the driver of growth, which obviously it is this year.

Headcount is playing out exactly as we wanted. We are actually very pleased. If you recall, we hired a lot of people at the end of last year, to set ourselves up well for growth this year. Took utilization down a bit in Q1. And then clearly we said we want to take utilization back up and that's exactly what we did. So we have great control over our hiring. And we're executing our plan of taking utilization up as the year goes on. We don't give specific hiring targets for the remainder of the year. But certainly we think there is a little bit more room for utilization though, Q2 was the big jump in utilization.

Sara Gubins, Bank of America Merrill Lynch.

Hi, good morning. I'm wondering for immigration reform if you're seeing any discussion with clients about it, if there are any delays in their decision making or the kinds of questions that they're asking. And also you talked about clients being ready to lobby on your behalf. Has that begun now that the Senate bill has passed?

Sure, Sarah, so with clients -- first of all, let me be very clear about this. There has been absolutely no change whatsoever in decision making as a result of immigration. The number of questions that we've gotten from -- received from clients have been few and far between. Where clients have asked question, we have been going out and meeting with them but the number of questions have been quite small and the discussion is more around, how do you think legislation will play out? And typically in those discussions, will come up, are there things that the customer says we as a company can do.

Generally the CIO won't have the authorization to go do it themselves, but what we're seeing they're certainly hoping to, reaching out to their Washington offices. Clients are getting involved. Some directly. And some through trade organizations. But it is a fairly small number. Which is appropriate at this time. What is important is for key ones to voice their opinion.

Julio Quinteros, Goldman Sachs.

Great. Hey, Gordon, just one real quick one, just to clean up the acquisition contributions for the quarter and for the year. I thought I heard both the C1 and SourceNet, but I think you guys cited the $10 million acquisitions, that was only for SourceNet. Can you just help us clean that up a little bit to know what the contributions are expected to be from C1 and SourceNet and then the organic implications underneath that?

Sure, Julio, this is Karen. So think about there is three pieces. There is the C1 and medical acquisitions which we talked about back in Q1. Those are still on track to do about $90 million of incremental revenue for the year.

And those were in our guidance.

That was in our original guidance. The only change this quarter is the addition of SourceNet which is $10 million of incremental revenue for the year.

Tien-Tsin Huang, JPMorgan.

Hey, thanks. Great quarter. Just wanted to ask about SG&A. It was surprisingly low, looks like only up 6% year on year. Can you break that down for us? What is sort of depressing the growth rate there? Thanks.

SG&A will bounce around a bit. In the end, we target an operating margin as we always have. This quarter came in a little bit high but obviously will come back down into the range next quarter as wage inflation kicks in. And so depending on where costs of goods land. But remember, what is -- part of what is happening here is we're growing and as we grow, there is more leverage of SG&A. So I would not read a whole lot into quarter to quarter movements in SG&A.

Ashwin Shirvaikar, Citigroup.

I know you guys do sometimes two sets of rate increases, one in May, one in July. Was that a shift in relative importance you give to the May one, versus the July one this year?

We simplified this year. So last couple of years, we split part of the population was in May, part was in July. We simplified it this year and we moved everyone to a July cycle. So the ones that are in May are now in July. The ones that were in July continue to be in July.

James Friedman, Susquehanna.

Hi, thanks. Karen, with regard to the unusually high tax rate 28.5%, I heard your commentary but it sounded like in the instance that the rupee were to go the other way, would the tax reverse? And then a follow-up related question. Did you say you had $0.07 of hedge-related losses in the quarter? Thank you.

Sure. Let me answer the second part of that first. So the $0.07 was the non-operating FX losses for the quarter. So that was on the, essentially on the I&R denominated, the net assets of the I&R asset, was the $0.07. Then separately, on the increase in the tax rate, that is due to the gain, essentially in our India books, on the US dollar denominated assets that are reported in our India statutory books. So yes, it if the rupee were to strengthen significantly, that would offset over time.

Darrin Peller, Barclays.

Thanks, guys. Just a question on the healthcare vertical. After a few quarters in a row seeing a little bit of a weaker trend, obviously it did show an acceleration in this quarter and I know, Gordon, I think you mentioned the paying side of it or the payer side of it. Can you give us a little more color on that? Is that something we can see as being sustainable? Obviously that is one of your -- has been historically one of your more important verticals and seeing strength in that is nice to see. Thanks.

Hi. Thanks. We were very pleased with the strength in healthcare overall, and a large part of it is driven by we are seeing broad-based growth across our payer clients and that is really across a spectrum of services that we offer. So we've seen really good growth there in our consulting business, our program management. We're starting to do a lot of IT and BPO stuff, assisting clients with participation in the new health insurance exchanges. So we're feeling very good about the payer side of the business.

The other side of the healthcare business is the life sciences business, and there I think it is going to take us a few more quarters. There is still lingering pressure on life sciences clients who are dealing with the patent cliffs. And I think that will bottom out over the next two or three quarters and then start to come back. So we are seeing good strong growth on the payer side. Still some lingering pressure on the life sciences side. But overall as you saw, a good quarter on quarter sequential growth so we're feeling good about the overall business.

Edward Caso, Wells Fargo.

Hi, thank you. I want to talk about the infrastructure outsourcing business. Maybe you could frame the size of it, as a percent of the total, what the competitive position and outlook is right now? It seems like everyone is talking about it. They seem to be larger deals. Could you also talk about the margin profile relative to your average? Thanks.

Hey, Ed. It is Gordon. Let me take the first part on size and then I will hand it over to Frank to talk about the market. Think about Horizon 2, BPO, infrastructure, and CBC, all those we've now got into critical mass. All three together are over 20% of revenue. Infrastructure alone is now, in terms of people, is measured, I think we're approaching 14,000 people, or so, so we're at critical mass in that business. Which means we can start competing in bigger deals. And that's one of the things that we're excited about, because it gives us the credibility now to compete in the bigger deals. Frank, you want to talk a little bit about the market?

I think as Gordon said, we feel good about our competitive position at this point. Obviously, we're playing in the asset light area of infrastructure management. We built a very strong credibility capability. Gordon in his prepared comments talked about the win up at Orkla which is just one example of a multi-year infrastructure deal. And there are several such deals that we are competing on and winning. So as the market shifts more towards looking at infrastructure as a viable candidate to move the global delivery model, and in addition, as clients look to leverage the cloud increasingly and infrastructure in the cloud, and that is driving a great deal of transformation infrastructure services, we feel like we're very well positioned.

In terms of margin profile on the business, we think that the margin profile in the business in the long run is very similar to the core business. We are investing in the business right now. So our SG&A in that business is higher than what it will be in steady state as a percent of revenue, and that is pulling margin down but the fundamentals of the business are such that we think in the long run will be very comparable to the core business.

Rod Bourgeois, Sanford Bernstein.

Hey, guys. Two topics. Could you just quantify how much margin boost you received in the quarter from the rupee depreciation and what that might look like in the current quarter? And to what extent the move in the rupee is enabling you to invest at a more rapid rate than you would have assumed at the beginning of the year? And just real quick as a second topic, could you just give us thoughts on your assumptions and your guidance for the rest of the year concerning discretionary spending? Thanks.

I will take the first part of that and turn it over to Gordon for the second piece of that. Regarding the FX impact on a sequential basis, there is about 30 basis points of margin improvement because obviously we have hedged a lot of our rupee exposure. So net of the hedge losses is about 30 basis points. Going forward, think about it as 10 basis points of margin improvement for every 1% movement in the rupee.

And on our assumptions about discretionary sending, as we said, we in the second quarter we saw continued healthy demand for discretionary spending. We saw it start at the end of Q1 and clearly continued into Q2. And based on what customers are telling us, the pipeline deals that are happening, we think that continues for the remainder of the year.

George Mihalos, Credit Suisse.

Hey, guys. Thanks for taking my question. As it relates to Horizon 2, can you break out the growth rates or maybe give us a sense if consulting, BPO and infrastructure management are growing in tandem or if one is out performing the other? As it relates to the UK, can you talk about the strength you saw there and was that all organic? Thank you.

So when you think about the Horizon 2, all three of them, overall, are growing faster than the Company. Each quarter one will grow a little bit faster than the other and some of that is low, small numbers but think about all three of these are businesses, as I just mentioned, that have now have critical mass, can play in bigger deals so we expect on a normalized basis all of them to grow faster than company average. Which one grows the faster quarter to quarter, that will flip around a little bit. The UK had no inorganic revenue, so that was all organic. Frank, you just want to comment on the business environment in the UK?

I think that for the last several quarters, across Europe, both on the continent and in the UK, the focus has been, our client focus has been on the run better services, so focused a lot on optimization of existing operations, looking to move more work to the global delivery model. I will say though that in the last perhaps one quarter, and I don't want to call it a trend yet, we have seen in the UK, particularly some pick-up in discretionary spending as well. As we see somewhat of an uptick in the UK, on business confidence and consumer confidence, we are also starting to see an uptick in the discretionary spending. A lot of that is focused on things like the SMAC stack, clients looking at deploying social, mobile, analytics and cloud.

We're also seeing things like omni channel with our retail customers. So we are starting to see, in the UK, some signs that discretionary spending is starting to pick up. And of course, there is always -- there continues to be a strong thrust, both in the UK and in the continent, towards the run better types of services. The run better types of services.

Glenn Greene, Oppenheimer.

Thank you. Good morning. Gordon, just want to go back to sort of the discretionary spending comments, get a little bit more color there. Kind of as a broad base, across verticals and geography, how much of the upside guide was due to this relative to market share gains, and kind of taking note of the eight strategic wins in the quarter, it seems like the deal activity actually accelerated as well. Maybe you could comment on that?

Sure. So I think the majority of the increase in guidance and over performance in the quarter was a result of discretionary spend. Because coming out of Q1, we saw the early signs of a pick-up in discretionary spend but we weren't sure if it had legs. Clearly, it had legs. So where we were a bit cautious on it, early on, we saw it materialize in the second quarter. So I would really point to your discretionary spend. Or what we refer to as the run different spend, being the big driver of over performance in the quarter and for the full year.

And then obviously, from an industry standpoint, banking did very well. It is a big business. And it did well. And the payer side of healthcare did well as well. So we're certainly pleased and perhaps a bit surprised on both of those.

David Togut, Evercore Partners.

Good morning. This is [Rana Kumar] for David Togut. Can you please quantify wage increases in the quarter and separately can you please discuss your current capital priorities, including if there is a discussion for an initiation of a dividend in the near term?

Sure. On wages, as we mentioned, our annual increments as well as our annual promotions all go into effect July 1. So there was no impact in the second quarter. Obviously it impacts in the third quarter. And that is why we guided to we would be back down into our normal operating range. On capital allocation, as Karen mentioned, we continued to repurchase shares during the quarter. As many know, we expanded our repurchase program earlier in the year, and we still have about $500 million left in that program. So the focus would be when and how do we continue to use that program.

Katy Huberty, Morgan Stanley.

Thanks. Just curious when you think about getting back to the targeted non-GAAP operating margin range, what are the factors that get you there in the third quarter? Obviously you have the salary bumps July 1 but do you also expect to step up hiring as you go into the back half of the year? And then maybe if you can just comment on the higher attrition. Where do you think those junior workers are leaving Cognizant to go to? Thanks.

Sure. So let me start with the first question on margin. The big driver is the salaries kick. Obviously we will continue to hire, but revenue is growing so that is offset. So it is really the wages, is the big thing. And implied in that is we continue to invest during the second quarter. I want to be very clear about that. Our investment continued at a very healthy pace.

Where do people go when they leave? They go to lots of places. The reality is Cognizant has an incredible training program. Obviously we're doing well in the marketplace so our people are in demand. So we lose to various multi-national competitors, to ISVs, as well as once in a while to other offshore companies. But I think what we see is -- and people understand is when you grow faster, which we're doing than the rest of the industry, it does create unique career opportunities. And we see that particularly with our highest performers where we see very low attrition rates, and we're very pleased about that.

So there is a pick-up in attrition. But this has happened many times in the past. We know how to deal with it. So obviously, we got to make sure we take it back down to where we like. But this has happened many times and it is normal course of business.

Jason Kupferberg, Jefferies and Company.

Thanks. Just a clarification and a question. The clarification on the tax rate, especially as we start to think beyond this year, are we saying that the rupee would have to appreciate for the tax rate to come back towards the 25% range versus the 27% range? And then just my question is, what percent of your new clients these days are initially engaging Cognizant in Horizon 2 or 3 rather than Horizon 1? And any comparison to what that percentage might have looked like a year or so ago?

Sure. So Jason, I will take the first part of that and then turn it over to Frank and Gordon for the second part. On the tax rate, what is really causing that spike to the 27% is the volatility in the rupee. So if the rupee were to stabilize at this rate over time, the rate would start to come back down because you wouldn't have that big swing in the gain or loss on the US dollar denominated assets. So we do not view that this is a permanent adjustment to this tax rate assuming that the rupee does start to stabilize over time.

And just on the other part of your question. It's Frank. I don't have a specific number, but my instinct is, it is about -- it has been increasing in terms of the number of new clients that we're winning, based on a Horizon 2 or I will add Horizon 3 to that service. We're actually adding new clients now based on Horizon 3 services, clients that have never done business with Cognizant in the past. If I had a specific number I would say it is about a third, 25% to a third of the clients. The new clients that we're winning, would be a Horizon 2 or a Horizon 3 service. And that is up from I would say two or three years ago, that would have been in the low single digits in terms of new clients for the Company.

So it is up quite considerably. And it is an indicator to me that once again, that those service lines are becoming competitive in their own right. And of course, we're having great success cross-selling into our existing client base, but we're also doing very well selling those services to new clients.

Steve Milunovich, UBS.

Thanks. Given your success in run different this last quarter, do you raise your $500 million for target for SMAC and which parts of SMAC are you seeing the most interest in?

I will answer the second part first. The places where we are clearly seeing the most attraction in SMAC are in the mobile space. There is just a tremendous amount of demand in mobility. That part of the SMAC business grew very nicely sequentially and more importantly, we're starting to see clients where we are doing large, ongoing steps of mobility work and a year or two ago, if we had looked at the mobile work we were doing, it would be small engagements in that space. And now we're starting to see real significant client engagement in mobility. The next after that, I would say, would be analytics. And there, there is just a tremendous amount of interest and opportunity to drive better business performance through big data and deep analysis.

Cloud is a very significant part of our business. But it is in a sense, distributed across many areas of our business. So cloud shows up in our infrastructure business. Cloud shows up in our enterprise applications business. So it is very distributed across all of Cognizant. And so I would point to those three as being the places where we're seeing the most traction. And of course, social, I would say to a lesser extent, but there continues to be some interest there as well, as to the example I gave in my prepared comments.

We don't update guidance on a service by service basis. We wanted to give you a sense last quarter of where we will land with SMAC this year. I still think $500 million is a pretty good number. Will it be a little higher than that? It could be based on the demand we're seeing, but I wouldn't want to update that on a quarter by quarter basis going forward.

Moshe Katri, Cowen.

Hey, thanks, nice quarter. Just clarification. You've bumped up guidance by about 200 basis points for revenue growth but then you bumped up EPS guidance by $0.01 for the year, maybe you can talk about that. I don't know if you did earlier on the call. And just another clarification here. We're focusing a lot on net headcount additions for the quarter. In your view, given the fact that you're focusing a bit more on non-linear growth, is this something we should continue to focus on as a proxy for top line growth? And maybe the effect of net headcount additions will probably not be as relevant down the road? Thanks.

Hey, Moshe, it is Gordon. On EPS, that is entirely due to the non-operating FX loss this quarter. We actually beat earnings this quarter by $0.07 more than reported because remember our guidance always excludes non-operating losses. So the reason you're not seeing as much EPS flow-through to the full year as revenue, is due to that $0.07 FX loss that we experienced, non-operating FX loss that we experienced during the quarter.

The net headcount additions, I would always be very careful on focusing on that. That's why we stopped giving guidance. Because there is a lot of seasonality for when we bring people on, when we want to take utilization up and down. For instance, late last year, we decided to bring on a bunch of people, consciously took utilization down in Q1 and starting to take it back up now. So I think you always want to be fairly careful about that. I'm not sure the non-linear stuff is materially moving the needle at this point on headcount additions. Because you also have BPO growing which takes it in the opposite direction. So that is more just utilization management.

Joseph Foresi, Janney Montgomery Scott.

Hi, would you describe the recovery as balanced or are there pockets of strength and weakness? And maybe you could give us a little bit more color on the financial services vertical. Have you seen a pick-up in discretionary spending there, particularly in capital markets or consulting? Thanks.

I would say -- it is Frank. I would say that in the US, I would call the recovery fairly balanced. We're seeing it across almost all of the industry sectors that we -- in which we operate. So the US I think, we're seeing good broad-based growth in discretionary spending. The only places I mentioned a little earlier in the call, that I think there is some lingering weakness is in our life sciences business. We talked to you about that last quarter, as well. But besides that, we feel very good about the US market.

As we look at Europe, I think the continent continues to be a story of different countries and different stories in the different countries, but there we're seeing more of a focus on cost containment and driving greater efficiencies, so the run better part of our business. And in the UK a little bit of a mixed bag. I would say broad-based growth but not as strong as it is in the US. So it is a little bit in the middle. So overall, I think that is the picture. And sorry, Joe, what was the second part of your question? I apologize.

I just want to know about financial services. A pick-up particularly in capital markets maybe you could give us a breakdown of demand within that vertical.

Again, as Gordon said, we were a little surprised that financial services came back in the last two quarters as comprised to the positive side in both quarters. This quarter we had good sequential growth there. The demand is coming from retail. It is coming from capital markets, retail banking and as we've said in the last two or three quarters, we've also started to see nice pick-up with the mid-sized banks in the US, as they start to adopt the global delivery model. In capital markets, some of our growth now is being driven by a pick-up in regulatory and risk management-related projects. And that often does include a consulting and sort of strategy and consulting piece up front.

Keith Bachman, BMO Capital Markets.

Hi, thank you. Two if I could. If you think about last year at this time, you were guiding to 20% year-over-year growth. And now you are guiding to call it 19% year-over-year growth. Would you -- could you characterize the visibility relative to those benchmarks that you currently have in terms of pipeline and deal flow to the 19% growth this year versus where you stood last year?

And then secondly, could you also just talk about cash flow targets for the year? For instance, last year you delivered about 16% of revenue with cash flow from operations. Would you anticipate about the same level of performance this year? Thank you.

Hey, Keith. It is Gordon. Let me take the first part and then Karen will take the second. So we just increased our guidance to 19%. Given it is mid August and in our business you have to ramp up the people and so forth, we have pretty good visibility on the remainder of the year. So I would say our visibility is similar to what it was this time last year. The time when you have less visibility is in February, before people lockdown their budgets. But by this time of year, people -- you have the natural flow. Obviously you can have new deals come in and that kind of stuff, but you don't have the macro surprises because that has all played out at this point and obviously, that's why we're pleased that we're able to raise our guidance. Let me have Karen comment on cash flow.

Sure. So we actually don't provide cash flow guidance for a number of reasons. But -- including we don't know the timing of acquisitions, what we might do under the stock buyback program and so forth. So I think we would expect the community to show strong cash flow from operations as we go into the back half of the year and we will continue to invest in capital expenditures as we talked about. And then when appropriate, utilize the stock buyback program. And do acquisitions as appropriate.

Dave Koning, Robert W Baird.

Hey, guys. Just one quick one. You said $10 million of revs from the SourceNet acquisition in the back half. Is that about $5 million a quarter? I'm just wondering if the timing of when it got done, so we correctly model it quarter by quarter.

Yes, so the acquisition closed beginning of June, end of May. And that is spread pretty evenly over the year.

Arvind Ramnani, BNP Paribas.

Two quick questions. Your Q4 guidance implies only about 2.6% sequential growth. What growth assumptions have you made in what seems like conservative guidance? And the second question is related to the immigration bill. I agree with your earlier comments that buyers of IT services are not worried about the immigration bill. However, have you made any changes to your recruiting efforts? And is there any medium to long term plan to reduce dependency on each one of these?

Sure, this is Gordon. Let me quickly hit the Q4 guidance and then discuss immigration. Q4, that is a quarter where you never quite notice there are is a budget flush, do people run out of budget as it gets through the year so you always want to leave a little bit of breathing room. And historically, Q4 tends to be weaker than Q3. So that is one way. There is always going to be a little bit of noise. Just repeat your immigration question again. Sorry.

Have you made any changes to your recruiting efforts? And is there medium and long term dependency to reduce your dependency on each one of these?

I think this is an important point. We have been evolving our model for a long time, well before the immigration debate started. Three years ago we started a US college recruiting program. We now recruit several hundred students each year. We have 75 recruiters recruiting US-based employees. So this is nothing new to us. We have been opening up your own development centers in the US. We now have centers in North Dakota, in Iowa, in Arizona, in Texas, in Florida and New Jersey. So this is an ongoing process for us.

The challenge is we have to hire thousands of people a year here in the US and it is challenging to find enough qualified IT professionals. Where we can find them, we hire them. But particularly in the locations that we need, it is a challenge. So it is a mix. Doing more local hiring is a propose that we've been doing for a while and will continue to do. I think that is -- we're at the eight o'clock mark. So with that, thank you all for joining us this quarter. Frank, do you have any final comments?

No, just thanks everybody for joining and we're happy with the quarter's performance and we look forward to talking to you again next quarter.

Thank you. This does conclude today's Cognizant Technology Solutions second quarter 2013 earnings conference call. You may now disconnect.