Cognizant Technology Solutions Corporation Q4 2009 Earnings Call Transcript

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Cognizant Technology Solutions Corporation (NASDAQ:CTSH) Q4 2009 Earnings Call Transcript February 9, 2009 8:00 AM ET

Executives

David Nelson – VP, IR and Treasury

Francisco D'Souza – President and CEO

Gordon Coburn – CFO and COO

Analysts

Tien-Tsin Huang – J.P. Morgan

Julio Quinteros – Goldman Sachs

Ashwin Shirvaikar – Citigroup

Adam Frisch – Morgan Stanley

Bryan Keane – Credit Suisse

Karl Keirstead – Kaufman Brothers

Rob Bourgeois – Sanford C. Bernstein & Company

Operator

Ladies and Gentlemen, welcome to the Cognizant Technology Solutions fourth quarter 2009 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions)

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

David Nelson

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

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'd now like to turn the call over to Francisco D'Souza. Please go ahead, Francisco.

Francisco D’Souza

Thanks, David and good morning from the NASDAQ in Times Square. Thank you for joining us today as we discuss our fourth quarter and full-year results for 2009. I'm delighted to report a strong quarter and year. Gordon will address financial and operating metrics later in call but let me offer you a few highlights.

During the quarter, we generated almost $903 million in revenue, up 6% sequentially and 20% on the year. Annual revenue rose 16.4% to close to $3.3 billion. Both during the quarter and on a full year basis, our growth was broad based with strength across our services and industries.

As I review our performance in 2009, it's gratifying to note that our strategy of staying even closer to our customers than ever before and investing back into the business for long-term success has paid off. We are clearly a stronger company today than when we entered the economic crisis.

During the downturn, we kept our eye on our long-term value drivers and maintained our program of concentrated investment. We invested in our people to gain a share from the talent marketplace as evidenced in the strong hiring in the last two quarters. We strengthened our existing service offerings and launched newer ones. We expanded our geographies, capitalized on some great acquisition opportunities and drove synergistic long-term alliances and relationships.

As a result, we're a much stronger organization financially with over $1.5 billion of cash, short and long term investments on our balance sheet and no debt. We're also a stronger firm competitively in our client relationships which continually deepen as evidenced by our financial results, our conversations with clients, our competitive win rates and our strong customer satisfaction results.

Some of the most notable areas of continued investment in the firm are our people, service offerings, alliances and new geographies. Last year, we added more than 16,700 people bringing our year-end headcount to over 78, 400. Even with that we boosted our full year utilization.

We recruited new talent across the globe and in all areas of our business. This includes about 140 people added to our client partner and account management team. As I said before, we believe we have one of the strongest client facing teams in the industry which has resulted in excellent client relationships and client satisfaction and has lead to a stronger channel to the market. Our biggest investment is in our talent and across the business in 2009 we attracted some exceptional people from campuses and from the lateral market.

As I reflect on our portfolio of services, I note that newer services like infrastructure management which we refer to as ITIS and BPO or KPO have now achieved critical mass, are growing nicely and are contributing to our financial results. These represent large market opportunities for us going forward.

We recently launched a new service offering in the area of engineering and manufacturing solutions or EMS through our relationship with Invensys. As I've told you before, this relationship opens up an entirely new market which will help us expand into core engineering, manufacturing and industrial automation solutions and penetrate industries that are now embracing global sourcing such as chemical and petrochemical companies in the process manufacturing space.

In corporate development activities, we're deploying capital in focused M&A opportunities and we're forging strategic alliances. Last year, we concluded more M&A and alliance deals than in the previous three years combined. For each of these link ups has reinforced a fast growing area of our business. For example, in addition to our Invensys relationship, which I've already touched on, we acquired Active Intelligence, a systems integration company specializing in Oracle retail solutions portfolio.

Integrating Active Intelligence's capabilities has solidified Cognizant's position as a leading provider of global services to the retail industry. With SAP in May, we announced a global services partnership underscoring our commitment to innovative SAP solutions in line with our vision of enabling businesses to meet the challenges of the new and changing global economy.

We signed a strategic partnership with Temenos, a market leader in core banking systems which add to the breadth and depth of our capabilities in banking and financial services technology and operations. We acquired Pepperweed Advisors which has strengthened our IT infrastructure services practice by broadening our portfolio of consulting offerings, advising on business performance risk management and infrastructure cost management.

And finally, we closed the acquisition of UBS India Service Center. This expands our financial services domain knowledge, broadens our geography and sharpens our KPO, BPO and IT infrastructure services capabilities.

We've also invested in expanding our geographic reach beyond the U.S. and Europe. You're aware of our efforts in Asia and the Middle East which grew 66% year-over-year in 2009. Additionally, we have expanded our delivery network in Mexico, Manila and Budapest and we've deepened our presence in the U.S. and Canada to serve a growing roster of U.S. and Canadian clients seeking in country and use of alternatives.

With that review of our accomplishments in 2009, let me look forward and discuss what we're seeing in the marketplace and how we expect this year to unfold.

The economies of the world have begun to recover and there is a more stable business climate when compared to a year ago. However, there remains considerable debate on the shape of the recovery and the so-called new normal in terms of long-term growth rates for key economies of the world. When I translate this to our client environment, the six years of 2002 to 2007 were stable and steady.

During this time, the majority of our clients had stable industry structures, business architectures and technology platforms. This environment enabled clients to focus first on improving efficiency and effectiveness in their business operations by taking advantage of low-cost offshore services and incremental process redesign initiatives.

It's now evident that the past two years have not just been a time of a major cyclical downturn but also that there was significant secular shift point for many of the industries we serve. These secular changes are driven by the megatrends of digitization and disintermediation, government mandated change and new disruptive technologies such as cloud social computing and virtualization coupled with accelerated competition from around the globe.

These shifts represent challenges and opportunities for our clients. Most of our clients have found that their long held business models and supporting technology environments have to be reinvented to cope with the new environment. With clients facing these twin challenges the economic slowdown which compels efficiency and effectiveness on one side and the secular shift which deals with new business models, our strategy and the corresponding investments that we've been making has been to build a range of capabilities to offer clients efficiency, effectiveness, innovation, transformation and virtualization all in one single platform.

Our approach has three main parts. The first is a drive to continuous improvement in the services we are currently delivering to clients in order to take clients to more class levels of efficiency and effectiveness.

The second is to extend our customer relationships by identifying core business process areas that we can redefine and offer a standalone solution across an industry. These opportunities are typically in process areas that are most impacted by the secular shifts happening in our clients industries. For example, security services in banking or pharmacovigilance in life sciences. They constitute new product type solutions that we can offer to our customer, allowing us to extend our customer relationships.

The third is to continue investing in our talent base to insure that we have deep expertise in the technologies, business process areas, consulting skills and methods that will be required to deliver on our vision to optimize and extend our client relationships.

Let's take a recent client example. Houghton Mifflin Harcourt is the world's largest publisher of educational material for pre-K through 12 schools. They selected Cognizant as a business technology services partner not only to provide IT services to drive operational improvement and to support their continuing expansion from print products to digital channels but also to co-develop innovative approaches and products to serve their markets. This comprehensive bundle deal will assist them to address the structural shift in the publishing business.

As clients increasingly come to recognize Cognizant as a company that can help them drive to greater levels of efficiency effectiveness, innovation and virtualization, we are investing to enhance our platform so that we can sell into these two areas of customer need.

Through Cognizant Business Consulting or CBC, we provide strategic consulting services helping companies identify opportunities to improve IT and business operations, lower operational expenses and enhance overall performance of IT and IT enabled processes. For example, our consultants are helping clients address industry changes such as the advent of ICD-10, a regulation hitting major healthcare players.

We are helping healthcare players streamline their operations and create new value-added services. Through our Web 2.0 based platform, Cognizant 2.0, we enabled the true virtualization of work and we are driving ourselves and as a result our clients to new levels of globalization.

With Cognizant 2.0, we have sold some of the most difficult challenges of real-time project management and knowledge management among teams of highly distributed professionals around the globe. And as our clients embark on significant enterprise level transformation programs, our ability to participate and often lead that change is essential. We are continuing to invest in large scale program management and change management so that we can be partners with clients in navigating change.

I hope that I haven't drove too much on our investment initiatives but we're excited by how powerfully all these pieces have begun to mesh together to reinforce our ability to deliver distinctive value by our clients, by integrating our understanding of our customers business environments with our significant operational capabilities.

Now, let's change gears and focus on our guidance for 2010. We are looking for at least $935 million of revenue in the first quarter or close to 4% sequential growth and at least $3.935 billion for the full year which equates to at least 20% annualized revenue growth.

Our guidance is based on the following observations. In contrast to last year, we see client budget cycles proceeding as they tend to during a normal year. In other words, at this stage, budgets are nearing finalization and are far enough along in the cycle that we have a view to clients' broad spending plans.

We think that clients IT budgets in 2010 will probably range from flat to slightly up, however, we believe the proportion of IT budgets that will be dedicated to offshoring will rise compared to 2009. Having said this as I mentioned earlier, there remains uncertainty about the level of the new normal economic activity in our key markets.

As a result, we have reflected that by taking a cautious view on the second half of 2010 until budgets are firmly locked down and our visibility to specific project work in the back half of the year improves.

With that let me turn the call over to Gordon who will detail our financial and operating results. Gordon?

Gordon Coburn

Thank you, Francisco and good morning to everyone. As Francisco mentioned, our strong revenue performance was broad based. During the fourth quarter, our financial services segment which includes our practices in insurance, banking and transaction processing grew 3.9% on a sequential basis and 11.8% on a year-over-year basis. It represented 41.9% of revenue for the quarter.

The current demand within financial services continues to be fairly broad, with clients focusing on cost controls and efficiencies, transformational projects, M&A integration, regulatory compliance and risk management. Healthcare continued its strong performance during the quarter with 6.1% sequential growth and 26.5% growth compared to the fourth quarter of 2008.

We experienced growth among both our life sciences clients and our healthcare insurance clients. These clients have used outsourcing to focus on cost control and are also using our business intelligence and analytics group to understand what is driving their overall costs. The segment represented 26.6% of revenues for the quarter.

Retail manufacturing and logistics was stronger than anticipated during the quarter. This segment continued the company leading growth that delivered during the earlier quarters in 2009 growing 11% sequentially and 31.8% year-over-year, representing 18% of revenues for the quarter. We are particularly pleased with the strength we saw in our retail sector where many of our clients continue their transition to global delivery and see the weak economy as a catalyst to accelerate these programs. The remaining 13.4% of our revenue came primarily from other service-oriented industries of communications, media and high technology, which grew 4.2% sequentially and 19.7% on a year-over-year basis.

For the full year 2009, financial services grew 9.5%, healthcare grew 25%, retail manufacturing and logistics grew 27.5% and our other segment grew 11.4%. For the quarter, application management represented 56% of revenues and grew 22.7% year-over-year and 6.2% sequentially.

Application development was 44% of revenues and grew 16.5% year-over-year and 5.2% sequentially. For the full year, management grew 21.9% and development grew 10.2% comprising 56 and 44% of revenues respectively. During the quarter, 78.8% of revenues came from clients in North America. Europe was 18.6% of total revenue and 2.6% came from the Asian Pacific, Middle Eastern and Latin American markets.

On a reported basis, Europe grew just over 2% sequentially in the fourth quarter. For the full year, Europe grew 12% and represented 18.5% of total revenue. It's important to note for the full year European revenue was negatively impacted by approximately $59 million due to the weakening of the European currencies in the latter part of 2008. On a constant dollar basis, Europe grew 23% year-over-year for the full year 2009 versus 12% on a reported basis.

As anticipated on a sequential basis, pricing remained stable. We had a gross addition of 57 new customers during the fourth quarter. We closed the quarter with 589 active clients. During the quarter, the number of accounts which we consider to be strategic increased by five. This brings our total number of strategic clients to 144. We continue to see a trend towards our newer strategic customers embracing a wider range of Cognizant services at an earlier stage in their relationship.

Turning to costs. On a GAAP basis, cost of revenues exclusive of depreciation and amortization were approximately $521 million for the quarter as compared to 420 million in the fourth quarter of 2008. Fourth quarter cost of revenues included approximately $3.4 million of stock-based compensation expense. The increase in cost of revenues is primarily due to additional technical staff both onsite and offshore required to support our revenue growth.

We increased our technical staff by close to 10,000 people during the quarter and close to 16,000 compared to December 2008. We ended the quarter with over 73,500 technical staff.

For the full year, cost of revenues exclusive of depreciation and amortization increased 17.6% as compared to 2008. Full year cost of revenues included approximately $14.9 million of stock-based compensation expense and 187,000 of non-cash stock-based fringe benefit tax expense from the first quarter.

Fourth quarter SG&A, depreciation and amortization expenses were $215 million on a GAAP basis, up from 190.6 in the fourth quarter of 2008. GAAP SG&A expense in the fourth quarter of 2009 included approximately $.4 million of stock-based compensation.

For the full year, SG&A, depreciation and amortization were 110.7 million compared to 726.8 million in 2008. Full year SG&A included approximately $30 million of stock-based compensation expense and about 750,000 of fringe benefit tax expense recovered from our employees.

Our GAAP operating margin was 18.5% for the quarter and our non-GAAP operating margin which excludes stock-based compensation and stock-based and fringe benefit tax expense was 19.9% within our target range of 19 to 20. The average rate for the rupee was 46.6 in the fourth quarter of 2009 versus 48.3 in the third quarter and 48.6 in the Q4 of 2008 -- once again, 46.6 in the fourth quarter of 2009.

$88 million of rupee operating expense cash flow hedges settled during the fourth quarter. This resulted in a $5.7 million gain which was recognized in operating expenses and partially offset the increased cost resulting from the appreciation of the rupee.

For 2010, we currently have $510 of rupee operating expense hedges in place at an average rate of 49.1 and we have $480 million for 2011 at an average rate of 48.3. And finally for 2012, we have $300 million at an average rate of 48.8. We had about $4.5 million of non-operating expenses. This was comprised primarily of an $11.3 million loss on our rupee balance sheet hedges partially offset by $6.8 million gain related to balance sheet remeasurements primarily associated with movements of the dollars versus the rupee, pound, euro and Swiss franc.

Our GAAP tax rate for the fourth quarter was 14.6% and for the full year was 16%. The fourth quarter and full year tax rates were below our original expectations due primarily to the tax impact of our foreign exchange hedges as well as the geographic mix of our earnings. We expect the full year 2010 tax rate to be approximately 16.8%. This anticipated increase from the 2009 rate is due primarily to the expiration in 2010 of tax holidays on two of our Indian development centers.

As we mentioned on previous calls during 2009, the Indian government extended the benefits of certain of our tax holidays through March 2011 which had originally been scheduled to expire in March of this year.

Turning to the balance sheet. Our balance sheet continues to strengthen. As Francisco mentioned, we finished the quarter with approximately $1,550 million of cash, short-term and long-term material investments, up over 210 million from the end of Q3.

During the fourth quarter operating activities generated over $237 million of cash, financing activities generated over $45 million of cash, comprised of the proceeds of our option exercises and related tax benefits as well as our employee stock purchase program. We spent approximately $14.7 million for capital expenditures during the year and 62.8 million for acquisitions and related costs.

For full year 2009, we spent $77 million on capital expenditures. This was below our prior expectations due to the timing of our new facilities and infrastructure requirements. For 2010, we expect to spend approximately $180 million on 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 $709 million balance on December 31, we finished the quarter with a DSO including unbilled receivables of 72 days compared to 71 days for the same period in 2008 and down about two days compared to the third quarter of 2009. The unbilled portion of our receivables balance was approximately $83 million at the end of the fourth quarter, a decrease of about $15 million compared to Q3. Over 60% of the December 31 unbilled balance was billed in January.

During the fourth quarter, 31% of our revenues came from fixed price contracts, flat from the third quarter of 2009 and up from 28% in the fourth quarter of 2008. For the full year, 30.3% of our revenues came from fixed price contracts.

Net headcount increased by over 10, 300 people during the fourth quarter and 16, 700 during the year. During 2009, approximately 44% of our gross additions were hired directly from college and 56% were lateral hires of experienced IT professionals.

Annualized turnover during the fourth quarter included both voluntary and involuntary improved sequentially by 110 basis points to 11.2%. On a full year basis, total attrition dropped to 10.3% from 14.2% in 2008.

As discussed previously, our medium term strategy has been to increase the company's utilization levels due to scale economies and historical heavy overinvestment in bench resources. We achieved that goal earlier than anticipated in 2009 as revenue grew faster than anticipated.

During the fourth quarter, we accelerated the hiring of both recent college grads and experienced IT professionals to position ourselves well to meet expected 2010 demand. As a result, our utilization levels in Q4 showed a decline versus Q3.

Offshore utilization was approximately 70% during the quarter. Offshore utilization excluding recent college graduates who were in our training program during the quarter was approximately 77%. Onsite utilization was approximately 89% during the quarter. At the end of the fourth quarter, we had over 6600 unbilled people in our training compared to 3400 at the end of Q3.

I'd now like to comment on our growth expectations for 2010. During his comments, Frank spoke about the twin challenges, cyclical and secular, which our clients are facing. These twin challenges are resulting in revenue opportunities for Cognizant in some of the key industries that we serve. Examples of these opportunities include first, M&A integration work across a number of key industries such as banking and financial services, healthcare and retail, the economic slowdown is driving consolidation in many of our industries.

Second, additional levels of outsourcing as clients increase the scope of what they are willing to outsource. For example, in our healthcare BPO practice, we are seeing increased traction invert it call process outsourcing areas such as claims, medical bill reviews, benefits coding and medical management.

Third, secular shifts of digitization and disintermediation, especially in the media and information industries. Information companies are being forced to rethink data delivery in the internet age requiring them to transform their integrated data supply chain. We have a long history of serving the information industry and are currently engaged in a number of multi-year programs to design and build new innovative and integrated data supply chains for our clients.

And finally, know your customer initiatives especially across our banking and retail clients. Given the hyper competitive markets today it's never been more important for our clients to know and understand the customers deeply and to develop innovative new capabilities to serve these customers. We are working on a number of initiatives to help customers create deep insight into their customer base. Among our retail clients in particular, we are working on a number of multi-channel initiatives to provide their shoppers with newer and more convenient ways to shop.

For the first quarter of 2010, we are projecting revenue of at least $935 million. This guidance includes a negative sequential impact of about $5 million in revenue due to the recent depreciation of the European currencies.

For the full year 2010, we continue to expect industry leading revenue growth. Based on current conditions and client indications, we are providing guidance for revenue of at least $9.35 billion. This represents growth of at least 20%. Once again that was $9.935 billion representing growth of at least 20%.

As Francisco mentioned earlier, our strategy of aggressive reinvestment is delivering results and we tend to continue the strategy this year. Therefore, we expect our operating margin to be in our historic target range of 19 to 20% before the impact of equity based compensation expenses.

Therefore, we are currently comfortable with our ability to deliver in Q1 GAAP EPS of $.48 and non-GAAP EPS of $.52 which excludes estimated stock-based compensation expense of $.04. This guidance anticipates a Q1 share count of approximately 304.7 million shares and a tax rate of 16.8%. This guidance excludes any non-operating foreign exchange gains or losses.

For the full year 2010, based on the current business trends, we expect our GAAP EPS guidance to be at least $2.03 and we expect our full year non-GAAP EPS guidance to be at least $2.19 excluding $.16 of estimated full year stock-based compensation. This guidance anticipates a full year share count of approximately 305.9 million shares and this guidance excludes any non-operating foreign exchange gains or losses.

We would now like to open the call for questions. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Tien-Tsin Huang with J.P. Morgan.

Tien-Tsin Huang – J.P. Morgan

Great. Thanks so much. Congrats on the strong results. Want to ask about the guidance. Does the 2010 guidance assume the same level of conservatism as last year when you set the guidance? And maybe if you can share a little bit more of what you're thinking for the second half?

Gordon Coburn

Sure. Tien-Tsin, our guidance of 3.935 billion includes conservatism for the second half but not the level of conservatism that we had coming into 2009. Obviously when we gave guidance in 2009 there was tremendous instability among many of our customers. This year there's a far greater level of stability that we've built in conservatism for potential second round of economic weakness in the macro economy.

Tien-Tsin Huang – J.P. Morgan

Got it. And then the fourth quarter, did you benefit from any kind of budget flush at all and as a follow on to that, did you see, have you seen any kind of change in client thinking around demand here in the last several weeks in particular between the U.S. and in Europe?

Gordon Coburn

Let me take the budget question and I'll turn it over to Francisco. As anticipated we did not see any meaningful budget flush inQ4. Things largely played out as we expected. We had a little bit more strength than we thought in the retail segment as some of those clients ramped up a little bit more than we anticipated but no meaningful budget flush. Do you want to comment on Q1, Frank?

Frank D'Souza

Yeah. I think just in terms of broad demand trends, clearly what we're seeing and we seen for now a quarter or two is as the environment has stabilized, clients are beginning to spend more both on the lights on stuff but also on discretionary projects and you've seen for now a couple of quarters application development and maintenance growing at give or take the same similar operates and so we're continuing to see that.

Having said that though, there is still caution out there, I think clients are still not sure what the new normal is going to be, so we haven't seen yet a return to, if you will, very large scale transformational engagements, truly large scale discretionary investments. Those are yet to come back in a significant way. What we are seeing is more incremental smaller projects that are discretionary and are somewhat transformational but clients are still not willing to commit to the big transformational programs.

Tien-Tsin Huang – J.P. Morgan

Any differentiation there between the U.S. and what you are seeing in Europe?

Gordon Coburn

I think we're seeing probably, the U.S. being a little bit ahead of Europe in that respect in terms of the return to discretionary spending but we're seeing very good signs in Europe as well. So I would say Europe might be a quarter behind the U.S. at this point, not more.

Tien-Tsin Huang – J.P. Morgan

Great. Thanks so much. Maybe just sneak in one last one on the use of cash priorities for the year and maybe, Gordon, just interest income for the year, what should we be modeling? Thanks a lot.

Gordon Coburn

Sure. Obviously our cash balances have increased to a little over 1.5 billion of combination of short-term and long-term investments and as well as cash. Our strategy remains fairly consistent. We want to have a healthy balance sheet. We continue to look for small acquisitions. Interest income picked up a little bit as we went through the year and part of that was driven by as we established a hedging program in India, on our balance sheet we were able to have a greater portion of our cash earning interest in India.

So we're currently thinking that our interest income next year, we'll certainly work off of the Q4 numbers, so somewhere in the mid to upper 20 million for the full year. Also, remember, Tien-Tsing, our CapEx number was quite low in 2009 because we had to absorb some of the stuff we had already built but we're starting another wave of construction, so as I mentioned our CapEx is going to go from 77 million last year to about 180 million this year.

Tien-Tsin Huang – J.P. Morgan

Great. Thanks.

Operator

Your next question comes from the line of Julio Quinteros with Goldman Sachs.

Julio Quinteros – Goldman Sachs

Great. Hey Gordon, can you just move quickly on the headcount plan going forward, just a sense on the percentage of headcount mix? So in other words how many of your heads as you kind of think about 2010 would be weighted towards offshore versus on site?

Gordon Coburn

Between offshore and on site, I don't expect any meaningful difference from the ratios we currently run which is about 77% offshore, 23% on site give or take. Over time the only thing that could skew that is depending on the growth rates of BPO, obviously BPO has much higher offshore component but if you exclude that I don't expect any material shifts in the business.

Julio Quinteros – Goldman Sachs

Okay. I'm just trying to triangulate back around the amount of heads if you will, relative to the kind of guidance that you have. I think, the inclination is probably to try and crank your revenue growth to your headcount growth but I just want to make sure that if your growth is going to be weighted towards offshore as I think you're suggesting, then that should kind of sort of balance out the revenue growth, expectations, is that the right way to think about that?

Gordon Coburn

There's another part to that as well. We brought a lot of people in the fourth quarter, some of whom start working immediately but others have to go through six months of training so this isn't just to position us for growth in Q1 but this is to make sure we have a healthy pipeline throughout the year.

Julio Quinteros – Goldman Sachs

The utilization, I guess would be the other lever?

Gordon Coburn

Exactly, so you'll see some bounce around in utilization without question.

Julio Quinteros – Goldman Sachs

Okay. And then just lastly, on some of the acquired contract contributions plus acquisitions, can you sort of strip down the 20% growth number for an organic constant currency number if you will?

Gordon Coburn

The one big acquisition obviously was UBS which closed at the very end of 2009. The other acquisitions we did were small and obviously we won some customers where we had staff transfer related to that, but those were really customer wins rather than acquisitions so the UBS one, let me pull that number and I'll get back to you during the call here on that.

Julio Quinteros – Goldman Sachs

That would be the moment, the most material, though.

Gordon Coburn

Yeah. Absolutely.

Julio Quinteros – Goldman Sachs

Okay. Great. Thanks guys, good luck.

Operator

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

Ashwin Shirvaikar – Citigroup

Hi, Frank. Hi, Gordon. Nice quarter. My first question is could you talk about the newer sources of revenues? Obviously, the more infrastructure had been on for a couple of years but has grown quite a lot in BPO and EMS. How big are they currently for Cognizant, when you say that it's beginning to be material and then can you talk about the margin profile relative to the core ADM business?

Gordon Coburn

Sure. Both IT IS which is infrastructure management and BPO, we're very excited about both of those. We saw growth rates for the full year that were way above the rest of the company. Obviously growing off of a small base but when you combine both of these, they're now getting up into the 10% plus range of revenue, so we're starting to get real traction, we're becoming a player in those spaces and we now have sufficient scale that we could compete in larger deals in both of those spaces. When you look at the margin profile, obviously, whenever you launch a new practice you build all of the practice overhead without the revenue to support it and that's part of our investment strategy so if you look at with all of the overhead certainly the profitability would be below company average today, over time though our expectation is that both those practices would hold their own from a margin standpoint.

Ashwin Shirvaikar – Citigroup

Okay. And then speaking essentially with TPI and EquaTerra and this has to do with the IT IS business, they both indicated that in their model companies could be ready in the near future to take on infrastructure as opposed to doing it remotely. How do you think about that and also how does the cloud computing push by clients affect that business?

Gordon Coburn

I think, Ashwin, I don't think that you'll see us acquiring large scale assets in the traditional way of infrastructure outsourcing. Having said that, we may do some selective client transfer of assets or potentially an acquisition that may get us some infrastructure because in the remote infrastructure management business. There often is a need to have some layer of infrastructure close to the clients. So I don't anticipate that we're going to get into the scale infrastructure business or the large scale take over of client assets but we will build out potentially infrastructure capability data centers and infrastructure capability in the countries that we serve or in the geographies that we serve as part of the need of our remote infrastructure management business.

So that's really how we're thinking about the overall business. I think there was a second part of your question which I didn't quite catch.

Ashwin Shirvaikar – Citigroup

How does the cloud computing affect that business?

Gordon Coburn

Yeah. So, I think that in terms of the remote infrastructure management business, specifically as it relates to remote infrastructure management I think there's a cloud computing shift in paradigm is somewhat neutral, whether clients host themselves or host in the cloud or are running their infrastructure within the cloud, we are neutral to that and we can manage and monitor and tend to clients infrastructure in any of those paradigms.

When you think about cloud computing as a broader paradigm at sort of the infrastructure level, the business process level, the application level and the SAS and so on and so fourth, software as a service, then I think the discussion is a broader discussion and probably one that bears more time than we can afford on this call.

Ashwin Shirvaikar – Citigroup

Okay. And last question, can you separate out trends in banking versus insurance and so on?

Gordon Coburn

In the fourth quarter, sequentially, insurance did quite well. BFS after having a tremendous third quarter still had growth but slowed down a little bit, so you saw a little bit of a rebalance in there but both businesses continued to grow.

Ashwin Shirvaikar – Citigroup

Thanks.

Gordon Coburn

And just to get back to Julio's question on UBS, the contribution of UBS will obviously depend on the ramp up of that account during 2010, but the upside opportunity if we had very aggressive ramp up, it could approach about 2% of revenue. Operator, next question?

Operator

Your next question comes from the line of Adam Frisch with Morgan Stanley.

Adam Frisch – Morgan Stanley

Thanks. Good morning and nice job on the quarter on the 2010 guide. Frank, you mentioned a number of exciting growth opportunities in your opening comments but which ones are you most excited about in 2010 and what are some things that you're working on that could add to the rapitore [ph] or the portfolio of services in 2011 and '12 that could eventually be material in the near term?

Frank D'Souza

I would point to a couple. I think that the first and most basic, we've talked about already are the opportunities in BPO and infrastructure management or IT IS. I won't dwell on those too long because we've talked about them many times on past calls and Gordon has already touched on that on this call as well, but we view those as having hit critical mass and if you look at sort of contributions in 2010 and in the short term, I think those are the ones that are going to have the most immediate impact.

Then there is EMS or engineering and manufacturing solutions, which we've just launched on the back of the Invensys relationship. I think that will take a little bit of time to play out. We obviously have a very healthy relationship with Invensys themselves, as a result of the deal we did a few months ago and we're starting to see a pipeline of opportunities building behind EMS.

My guess is that that will start to translate into significant revenue or material revenue growth for us probably three, four quarters from now, as we build out that practice and the third area that I would highlight has to do with this broad trend that we see across all of our industries and it's not a specific service offering as much as it is an ability to serve clients and it's what Gordon and I both touched on which is that as we start to see stability in the key markets around the world in the U.S. and in Europe in particular.

We're seeing clients come to us saying, you know, that we're really in this, client are saying we are in this difficult position of having continued cost pressures on the one side being driven by the fact that we're not out of the woods yet on the cyclical environment, but at the same time clients facing a lot of secular pressures from changing industry dynamics, whether that's digitization, globalization and so on and so forth. And what really the value proposition that we have that really is resonating with these clients is the ability to go to a client for us to go to a client and offer them what we think of as an efficiency and effective value proposition on the one side which is all about the cost side of their income statement if you will.

And on the other side an innovation and virtualization value proposition which is about the revenue side of their income statement and also potentially the CapEx side of their balance sheet. So we're able to go to a client and say we can help you across cost revenue and CapEx on your balance sheet and that's very powerful paradigm.

Adam Frisch – Morgan Stanley

Okay. Great. Thanks for that color. Just wanted to touch on the people side for a second. Your technical headcount was up 25% year-over-year. Can you talk about your hiring plans in 2010 and where you think utilization rates will average out over the year?

Gordon Coburn

Sure. Utilization rates, I think we're right around where we want to be, so I don't expect any material trends one way or the other from 2009 utilization. Obviously, we made tremendous progress in utilization increases 2008 going to 2009. So we achieved those goals. Hiring will depend on what happen -- where exactly revenue settles down and the pattern of revenue.

Obviously, we replenished the bench in late in Q4 both with laterals and equally importantly with freshers, who don't become available for billing until the middle of the year because of the six month training program. So we think we're well positioned from a supply standpoint and we continue to have the ability to go into the lateral market as aggressively as we need to throughout the year.

Adam Frisch – Morgan Stanley

And wage inflation is not anything that's a concern right now?

Gordon Coburn

No. I think it will be wage inflation this year. We actually announced to our employees a couple weeks ago that we will be doing salary increases primarily during the June quarter. We don't know the size of those increases yet. Obviously, we're waiting to see what the competition does in terms of magnitude of increases but I'd certainly expect that there will be some wage increases this year.

Adam Frisch – Morgan Stanley

But that's manageable, right?

Gordon Coburn

It's built into our guidance absolutely.

Adam Frisch – Morgan Stanley

Okay. Cool and last question. Obviously, the tax holidays are a topic that's becoming more in focus now some think that the government is going to make a decision on this at the end of February when they announce their budget. Can you talk about most people I think that tax rates are going up next year. Are you prepared to do some kind of buyback to offset the impact there or just wait until it gets normalized in 2011 on the bottom line?

Gordon Coburn

If there's so many moving pieces on the India tax structure. One question obviously is there an extension of the STPI tax holidays beyond March 2011. But also keep in mind the Indian government has proposed a complete revamping of the tax structure in India and essentially going more towards a flat tax. So we'll wait to see what comes out at the end of February and then certainly there will be a lot of just healthy discussion and debate, which I think ultimate will turn into a tax policy that will be good both for the government and continue to support economic investment and growth in India.

Adam Frisch – Morgan Stanley

Okay. Thanks, guys.

Gordon Coburn

Thanks.

Operator

Your next question comes from Bryan Keane with Credit Suisse.

Bryan Keane – Credit Suisse

Hi, good morning. Very solid quarter. I noticed the Financial Services vertical in Europe both grew a little bit less than the company average sequentially and we touched on it a little bit, but I guess I'm curious if this trend should continue into 2010 or is it kind of a just a one-time quarter phenomenon?

Frank D'Souza

Brian, it's Frank. What we saw in Europe was after very, very strong growth in Financial Services in the third quarter. As you pointed out, Financial Services leveled off a little bit in the fourth and that was primarily driven by one client where we ramped very aggressively in the third quarter for some M&A integration work. So there was a very strong growth in the third quarter and that leveled off as we ramped the team and guided to the current level for the M&A integration work. It sort of leveled off in the fourth quarter. And so over the next couple of quarters, I expect to see Financial Services in Europe start to return to more normalized growth rate once since we will be through this one-time ramp up of that client.

Bryan Keane – Credit Suisse

Okay. And I was hoping to get some updated thoughts on potential wallet share gains for offshore services. The often question that comes up is how saturated is offshore services in some of these industry verticals. Maybe you can give us your thought there.

Frank D'Souza

I think you have to look at it by industry and also by geography because the answer is a little different. But overall, I think that what's happened over the last few years is that the addressable pie for offshoring has increased so that's actually creating saturation levels that are lower than you would have otherwise thought. Because we've gone from the applicable or the addressable pie being just IT and applications to BPO and IT infrastructure services and as we've moved to other parts of the world from the U.S. and the U.K. to Europe and now increasingly Asia-Pac, that's also increasing the addressable market.

The core domain knowledge that we have in the industries that we serve is a core asset that we're able to use to leverage new service offerings. So for example, the domain expertise that we gained in as a result of doing work in banking and IT and banking and life sciences and so on. We're leveraging that in our BPO business to grow the BPO business. So we're able to take core assets that we develop in one service line and leverage them into other service lines, which helps our growth in those new service lines. So overall the pie is expanding and saturation levels are not going up, in fact they're coming down because the pies are expanding.

Bryan Keane – Credit Suisse

Even in Financial Services, would you say the same thing?

Frank D'Souza

Yeah. I think so.

Bryan Keane – Credit Suisse

Okay. Last question for me, just pricing. What's embedded in the guidance for 2010, Gordon? Thanks a lot.

Gordon Coburn

The guidance for 2010 does not assume any material changes, as I think we said on the call pricing was stable in Q4 and when we looked to 2010. We think it's stable with a slight upward bias so not losing a whole lot of sleep over pricing, hopefully we'll pick up a little bit of advantage here and there.

Bryan Keane – Credit Suisse

Okay. Thanks.

Operator

Your next question comes from the line of Karl Keirstead with Kaufman Brothers.

Karl Keirstead – Kaufman Brothers

Hi, got a couple questions about the guidance. First, Gordon, I hear the conservatism around the second half and it feels like if you strip out UBS roughly 18% full year guidance reflects that. But from an operational standpoint 10,000 hires in the fourth quarter and a big CapEx increase to increase your facility footprint sounds like from an operational standpoint, you're managing a business for greater growth than that. So could you just maybe bridge the gap between the big headcount in facilities expansion yet your conservative outlook? Thanks.

Gordon Coburn

Sure. Let me hit the easier one first on CapEx. These will be construction programs that obviously won't come on line in 2010. This is for looking out to 2011, 2012. On the people, utilization got pretty high in the third quarter. So we needed to moderate that a little bit and also we brought on a lot of, if you think about the 10,000 people that we brought in some will be available for billing in the first half of the year, the other are really pipeline to become available for billing in the second half of the year.

So the bigger question, Karl, ends up being what do we do with lateral hiring in Q1 and Q2 and that we'll decide as we continue to get visibility into the back half of the year. But we wanted to make sure we don't get caught short of resources and we have the luxury of being able to slowdown or speed up lateral hiring as we go through the year to adjust to it.

Frank D'Souza

There's one other piece to that, Karl, which you have to remember is that of the 10,000 that we brought on in the fourth quarter, a couple thousand of those were UBS folks who came over. So you got to take that out if you're comparing the -- if you're taking out the 2% from the guidance then you take out the couple thousand from the headcount as well to get apples-to-apples.

Karl Keirstead – Kaufman Brothers

Got it. Okay. That's helpful. And on the Q1 guidance, if we add back 5 million for the expected FX hit but if we deduct let's just say 15 million or so for UBS. It looks like a constant currency sequential guide of about 2 to 3%. Does this reflect your conservatism or is there anything in Q1 that you're cognizant of so to speak in your guidance?

Gordon Coburn

I would not view it as conservatism. There are two things in Q1. First, of all 3% less billing days in Q1 than Q4, the way the calendar breaks this year 3% less than Q1 and then in Q2 versus Q1, it goes up by 4%. And second, as Francisco mentioned, this is a very normal budget cycle year and in a normal budget cycle year January is always soft until people have their budgets locked and loaded and then in Q2 you get the full year, the full quarter impact of the new budget cycle. So if you look historically other than last year that tends to be the trend Q1 is always a little softer for those two reasons.

Karl Keirstead – Kaufman Brothers

Okay. Great. That's helpful. And I could sneak in one more. Gordon, your guidance on the top line is 20%, GAAP EPS growth more like 14. What's the offset? I think you mentioned the tax rate going up. Is there anything else we should be aware of as we model?

Gordon Coburn

The big one is -- that really two things. The tax rate going up and I'm talking on a non-GAAP basis we were at 20.3% operating margin in 2009. We expect to be or we're modeling about 19.8 for 2010. So we're getting back into our operating margin range plus the tax rate goes up.

Karl Keirstead – Kaufman Brothers

Got it. Thanks for the color.

Gordon Coburn

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

Operator

Our last question comes from Rob Bourgeois with Bernstein.

Rob Bourgeois – Sanford C. Bernstein & Company

Hey, guys. So Cognizant has out grown the top Indian firms on a rolling 12 month basis in every period over the last five years and I guess I'm asking at this point. Is there anything that would change Cognizant's ability to continue gaining share versus the other top Indian firms, after accounting for their latest plans to increase their capabilities?

Gordon Coburn

Years ago, Rob, we made this decision to keep our margins lower than our competitors and take those dollars and reinvest for long-term revenue growth. And what we said to our shareholders is in return for that privilege of having a lower margin, we -- our goal and our commitment is to grow faster on an organic basis than others in the market. The investment strategy is working. In 2009, we grew substantially faster than others. We're positioned, we are winning a proportion at share of deals and where deals are shared we tend to ramp up faster. So based on this strategy, we would certainly be disappointed if we don't have industry leading growth on our organic basis.

Rob Bourgeois – Sanford C. Bernstein & Company

All right. Great. And then on the margin side, I'm assuming the street should fully expect that you'll bring your operating margin back into your non-GAAP target range of 19 to 20%. And so if I make that assumption, can you just give us some thoughts on what would be the swing factors that would cause you to be at the upper end of that range versus the middle of the range, versus the lower end of the range? Is it the Rupee wage inflation in pricing that are the swing factors or is there a way you can help us handicap. What would be the differentials between being at the low end versus the high end?

Gordon Coburn

It's really four things. What happens with revenue wage inflation, the Rupee and what we do with the utilization, we serve our goal certainly is not to be at the low end of the range. We like to be at the middle to upper end of the range and as I mentioned our assumptions are -- we're around 19.8% or so. But we certainly do not want to be above the range. Obviously, what happened this year was we particularly for Q3 where we saw tremendous surge in revenue and there for a surge in utilization. We had not anticipated that and there for, obviously margins popped out of the range. But we've increased our discretionary spend and also we've normalized our utilization. So my expectation is we're in the upper half of the range.

Rob Bourgeois – Sanford C. Bernstein & Company

Okay. Great. Thank you, guys.

Gordon Coburn

All right. Thanks, Rob.

Francisco D’Souza

Thanks everyone and thanks for joining us on the call. We spend more time than usual on this call outlining the framework for our performance in the coming years and beyond. But we remain very proud of our achievements and I'd like to recognize the achievements of our associates in excelling through the challenges of 2009. Our 16.4% in annual revenue growth has helped us once again maintain our distinction of leadership among our peers and our value proposition continues to deliver strong results to our clients. Thank you for joining us today and we look forward to speaking with you again next quarter.

Operator

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

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