Cognizant Technology Solutions Corporation
Q4 2010 Earnings Call Transcript

Published: 7 Feb 2011

[Operator:]

Ladies and gentlemen, welcome to the Cognizant Fourth Quarter and Full Year 2010 Results Conference Call. [Operator Instructions] I would now like to turn the conference over to David Nelson, Vice President, Investor Relations and Treasury. Please go ahead, sir.

[David Nelson:]

Thank you, and good morning, everyone. By now, you should have received a copy of the earnings release for the company's fourth quarter and full year 2010 results. If you have not, a copy is available on our website, cognizant.com. The speakers we have on today's call are Francisco D'Souza, President and Chief Executive Officer; and Gordon Coburn, Chief Financial and Operating Officer of Cognizant Technology Solutions. Before we begin, I would like to remind you that some of the comments made on today's call and some of the responses to your questions may contain forward-looking statements. These statements are subject to the risks and uncertainties as described in the company's earnings release and other filings with the SEC. I would now like to turn the call over to Francisco D'Souza. Please go ahead, Frank.

[Francisco D'Souza:]

Thank you, David, and good morning, everyone. Thank you for joining us today. I'm pleased to report that 2010 was another strong year for Cognizant, capped by another quarter of industry-leading growth. In Q4, our revenue grew almost 8% sequentially and 45% over last year to over $1.3 billion, with increases spread broadly across sectors, services and geographies. During 2010, we saw a surge in discretionary spending, resulting from the release of pent-up demand following two years during which our client underinvested in technology. As a result, we finished 2010 with 40% revenue growth year-over-year, considerably stronger than the 20% growth that we had anticipated at the start of the year. Against this backdrop of sudden, strong demand, two things stand out about Cognizant's performance

[Gordon Coburn:]

Thank you, Francisco, and good morning to everyone. During the fourth quarter, we experienced continued strength in our Financial Services segment, which includes our practices in insurance, banking and transaction processing. This segment grew 6.6% on a sequential basis and 46.5% on a year-over-year basis. It represents 42.3% of revenue for the quarter. For the year, Financial Services grew 38.2%. The demand within Financial Services was broad based across our clients. We saw a continued focus on initiatives to drive cost efficiencies and operational effectiveness, projects related to regulatory compliance and risk management, discretionary innovation initiatives to enhance competitive positioning and finally as expected, M&A integration work was extended through the end of 2010. Healthcare continued its growth during the quarter with 11.9% sequential growth and 41.2% growth compared to the fourth quarter of 2009. This segment represented 25.9% of revenues for the quarter. We experienced similar sequential strength in both our healthcare insurance clients and life science clients. For the full year, this group grew 36.8%. Similar to Q3, demand within these clients was driven by investment in data warehousing and analytics services to better understand and control medical costs, expansion of BPO services including clinical operations, claims, benefits coding and enrollment, ICD-10 code sets, 5010 assessment and remediation work and finally, platform modernization initiatives. Manufacturing, Retail and Logistics had a stronger-than-expected fourth quarter, considering that our retail clients often slow down new development during the holiday season. This segment continued to build on the growth from earlier in the year, growing 5.6% sequentially and 49.4% year-over-year. It represented 18.6% of revenues for the quarter. For the year, this segment grew 50.4%. Demand within the segment was driven by an increase in large-scale transformational and systems integration projects among our major manufacturing clients. For our retail clients, we saw an increase in business transformation projects such as service platform development, modernization of core retail systems and multi-channel expansion, especially in e-commerce. In addition, we have seen an increased interest in customer segmentation initiatives, which we refer to as Know Your Customer projects. The remaining 13.2% of our revenue came primarily from other service-oriented industries of communications, entertainment, media and high technology, which as a group, grew 6.3% sequentially and 43.2% on a year-over-year basis. For the full year, this segment grew 39.1%. For the quarter, Application Management represented 50% of revenues and grew 31% year-over-year and 7% sequentially. Application Development was 50% of revenues, grew 64% year-over-year and 8% sequentially. For the full year, Application Management grew 30%, while Application Development grew 52%. During the quarter, 77.2% of revenue came from clients in North America. Europe was 19.2% of total revenue and 3.6% of revenue came from the Asia Pacific, Middle East and Latin American markets. For the quarter, Europe grew by 9.8% sequentially and 50.3% year-over-year. During the fourth quarter, European revenue was positively impacted by approximately $6.2 million compared to the third quarter due to the strengthening of the European currencies. On a constant-dollar basis, Europe grew 7.1% sequentially. Pricing, on a sequential basis, was up 1.5% on site and 2% offshore. We continue to have success in our pricing discussions with our existing client base and expect to continue to see the benefits of these ongoing discussions over the coming quarters as rate increases continue to kick in. We had a gross addition of 61 new customers during the fourth quarter. We closed the quarter with 712 active customers. During the quarter, the number of accounts which we consider to be strategic increased by six. This brings the total number of strategic clients to 166. We continue to see a trend towards newer strategic customers embracing a wide range of Cognizant services at a earlier stage in the relationship. Turning to costs. On a GAAP basis, cost of revenues exclusive of depreciation and amortization was approximately $758 million for the quarter and included approximately $3.3 million of stock-based compensation expense. The increase of cost of revenues is primary due to additional technical staff both on site and offshore required to support our revenue growth. We increased our technical staff by over 8,100 during the quarter and ended the quarter with over 97,700 technical staff. Fourth quarter SG&A including depreciation and amortization was $307.9 million on a GAAP basis and included approximately $11.7 million of stock-based compensation expense. Our GAAP operating margin was 18.7% for the quarter and our non-GAAP operating margin which excludes stock-based compensation expense was 19.8%, within our target range of 19% to 20%. The average rate for the rupee was 44.8% in the fourth quarter of 2010 compared to 46.4% in the third quarter and 46.6% in the fourth quarter of 2009. $165 million of rupee-denominated operating expense cash flow hedges settled in the fourth quarter. This resulted in a $14.3 million gain, which was recognized in operating expenses. We have recently extended our hedging program into 2014 with over $2.6 billion in outstanding hedges of our rupee expenses. We currently have contacts with a notional value of $780 million scheduled to mature in 2011 with a weighted average forward rate of 48 rupees to the U.S. dollar, $900 million in 2012 at a rate of 48.2%, $840 million in 2013 at a rate of 50.1 rupees and $120 million for 2014 at a rate of 52.2 rupees. As predicted, our GAAP tax rate for the fourth quarter was 17.1%. For the full year, our tax rate was 16.5%, both in line with prior guidance. Our diluted share count for the fourth quarter was 311.8 million shares, up from 309.6 million in Q3. During the fourth quarter, we announced a $150 million share repurchase program. We repurchased 600,000 shares during the fourth quarter at an average price of $69.77 for a total cost of $41.9 million. Turning to the balance sheet. Our balance sheet continues to strengthen and remains very healthy. We finished the quarter with over $2.2 billion of cash and short-term investments, up approximately $298 million from the end of Q3. During the fourth quarter, operating activities generated over $392 million of cash. Financing activities resulted in the use of $14.5 million of cash, comprised of proceeds of option exercises and related tax benefits as well as our employee stock purchase plan, offset by $41.9 million of share repurchases under our stock repurchase plan. We spent approximately $75 million for capital expenditures during the quarter. For full year 2010, we spent $185 million on capital expenditures. For 2011, we expect to spend approximately $285 million on capital expenditures, the substantial majority of which will support another wave of facilities expansion. Based on our approximately $1 billion receivables balance on December 31, we finished the quarter with a DSO, including unbilled receivables, of 71.2 days, down from 80.5 days in the third quarter. During the fourth quarter, we implemented additional processes to refocus our teams on DSO. The drop in DSO was largely an outcome of this work. The unbilled portion of our receivables balance was approximately $113 million at the end of the fourth quarter. This is a decline of $32 million or 22% from the third quarter of 2010. Approximately 60% of the Q4 unbilled balance was billed in January. During the fourth quarter, 32.3% of our revenue came from fixed bid contracts, up from 31.2% in the third quarter of 2010. For the full year, fixed bid contracts were 31.5% of our revenue. Net headcount increased by 8,345 people during the quarter, of which, approximately 47% of the gross additions were hired directly from college and 53% were lateral hires of experienced IT professionals. We ended the quarter with approximately 104,000 employees globally. As expected, we saw a decline in attrition during the fourth quarter as compared to Q3. As we have discussed in the past, there is no consistent methodology in the industry to report attrition numbers. We have historically reported attrition by annualizing the turnover which occurred within the quarter, including both voluntary and involuntary. This number has decreased sequentially to 16% in the fourth quarter. It is important to note that our attrition statistics include all departures, including BPO and employees in our training program. Offshore utilization was approximately 73% during the quarter. Offshore utilization excluding recent college graduates who were in our training program during the quarter was approximately 82%. On-site utilization was approximately 91% for the quarter. At the end of Q4, we had over 9,500 unbilled people in our training program. As we look at 2011 and beyond, Cognizant and our industry are at an important inflection point. Francisco highlighted opportunities this creates for us from a market standpoint. I'd like to take a moment to comment on our key operational priorities as we focus on ensuring that our people, processes and infrastructure are prepared to support these opportunities. Our top priority is to remain the employer of choice in our industry. We want to ensure that we continue to attract and retain associates who are smart, curious, collaborative, entrepreneurial, team oriented and results oriented. We want people who continue our tradition of viewing the success of Cognizant and its clients as a proxy for their own personal growth and ambitions. Finally, we want to ensure that we are doing what's necessary to be the employer of choice of the millennials and the millennial-mindset associates. Our activities in this area include

[Operator:]

[Operator Instructions] Your first question is from the line of Tien-Tsin Huang of JPMorgan.

[Tien-Tsin Huang:]

I wanted to ask about the regulatory changes you talked about, Frank. Lots of going on in the financial services as opposed to healthcare sector as well in terms of reg [regulatory] reform. And it sounds like reg compliance is going to pick up once the rules are written in the second quarter? My question for you is how much of this reg spend or reg compliance spend is going to be incremental versus perhaps cannibalizing some of the transformational work you're talking about? And also, can we see some delay in the first half budgets across the banks being deployed and then pick up later in the year given the timing of some of these changes? Any color on that stuff would be helpful.

[Francisco D'Souza:]

Sure. I think let me focus my comments on the financial regulatory reform as opposed to healthcare. In financial regulatory reform, at this point, as you know, the regs have not been written yet. So we are not seeing clients yet implementing system changes because they're waiting for the regs to be written. Now we have started, in a few cases, engaging in some consulting projects but that's relatively small revenue at this point. Our current outlook doesn't include a significant factor for large scale technology change relating to financial regulatory reform, because we just don't have enough visibility to know what's going on out there at this point. In terms of budgets, we don't see our clients in Financial Services holding back or delaying budgets as a result of the uncertainty that fin reg is creating. Instead, we see clients making some assumptions about the magnitude of work that will need to happen in their budgets and then proceeding with the relatively, what I would consider, normal budget cycle in terms of the timing.

[Operator:]

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

[Julio Quinteros:]

Maybe just a little bit of a balance between the additional capacity that you guys are adding. So it looks like you can add another 55,000 in heads. But I guess I'm trying to find the balance between that and investments in some of the other things that you talked about, Francisco, in terms of platform-based investments, more IP-type investments? I guess this question really just gets down to the whole issue of non-linear growth and what investments you're making on that front so that this model, a couple of years down the road, is not just purely headcount, especially given all of the changes on the technology front? Maybe you can just address those two fronts, that would be great.

[Francisco D'Souza:]

Julio, I'll comment on the non-linear revenue front and then maybe Gordon can add some color around our specific real estate plans. So we continue to make investments in building out IP-based, non-linear revenue streams. It's still early days but the example I gave in my script around Eli Lilly is a great example of that. It's a fully integrated service that we're deploying, in the process of deploying for Eli Lilly, where we will provide them the platform itself, a software platform and the infrastructure on which that platform runs. And on top of that, you can think of it as a BPO service to run and operate the platform. And we provide that to them in an integrated way and that, by the way, is a platform that we think is broadly applicable across pharma, not just limited to Eli Lilly. And we have systematically identified opportunities like that across each of our vertical businesses and now increasingly, within each of our horizontal businesses. And we're making the investments to build out and to support those kinds of non-linear revenue streams. Like I said in my comments, this is a journey, it will take us time to shift the revenue mix meaningfully to these kinds of revenue streams. Which is why at the same time, the traditional model, the headcount-based model is one that we see tremendous growth and upside and opportunity on, and that's why we will continue to do the things we need to do to remain vibrant in that side of the business, including adding capacity.

[Gordon Coburn:]

And in the capacity, Julio, what we think about is we'll never completely break the linearity between revenue and headcount obviously. So what we want to do is make sure we have enough flexibility in our growth of infrastructure. So depending on how much we are successful in non-linear services we'll have the appropriate amount of infrastructure. So what we do is in our own facilities, that creates a core level of growth, and then we will always supplement our own facilities with leased facilities, and that will become the variable. So depending on what our capacity needs are, we'll either lease more or less facilities in addition to the own facilities that we're constructing.

[Operator:]

Your next question is from the line of Rod Bourgeois of Bernstein.

[Rod Bourgeois:]

Looking into 2011, I was hoping you could give some more specificity on some of the assumptions in your full year 2011 guidance? Specifically, is your revenue growth guidance embedding an assumption that discretionary spending may not be as strong in the second half of 2011 as it is right now? Or is there any other form of prudent conservatism being in embedded in the guidance at this point?

[Gordon Coburn:]

We always embed some conservatism in our guidance. We are not expecting a slowdown in the economy in the second half of the year. But due to its nature, discretionary spending has less visibility, so our guidance assumes that we certainly don't win every project that's out there. So the conservatism is more built into what is our win rate on development work as we go through the year. And obviously, if things hold up the way they were tracking last year, we probably would end up with some conservatism in there. But there's nothing that we're seeing, in talking to our clients, where they think they're going to slowdown overall discretionary spending in the back half of the year.

[Rod Bourgeois:]

And Gordon, is that conservatism evenly spread across your different verticals or is it more pronounced in certain areas like Europe or in certain verticals?

[Gordon Coburn:]

If I think about by verticals now, it's evenly spread. Certainly for Continental Europe, we still have some caution there. But beyond that, it's evenly spread.

[Operator:]

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

[Bryan Keane:]

Gordon, just wanted to ask you, if you step back and look at the revenue growth rate for 2010 of 40% and then the guidance being set to at least 26%, what are the key differences there? Is there just less discretionary spend or also less M&A work when you just look at those two numbers, when you step back and look at the big picture?

[Gordon Coburn:]

I think discretionary spend is actually quite healthy. The biggest difference though is in 2010, we benefited significantly, particularly in the second and third quarter of pent-up demand from 2009. So there was an unusually high level and surge in project starts in sort of the middle of 2010, because people just didn't do discretionary work. And then we got more back towards a steady state rate. So now discretionary spend, I think, remains quite healthy but certainly, you don't have two years of spend all pent up and released all at once. So I think that is the single biggest difference.

[Bryan Keane:]

Just a quick follow-up on pricing, almost up 2%, what should we expect pricing to be up for 2011?

[Gordon Coburn:]

On an apples-to-apples basis, I think we'll continue to see improvements in pricing realization. Now obviously the wildcard is what mix shift do we shift more towards, BPO, et cetera, et cetera. But I don't know if will be every quarter pricing will be up. But certainly when we look at 2011 over 2010, we would certainly expect to be up several points.

[Operator:]

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

[Adam Frisch:]

To your credit, there was a lot achieved in 2010 in terms of your service offering that will be repeating in 2011 and subsequent years. But there was also some things that may not repeat. So I'm wondering if you can quantify maybe the one-time projects or the things you spoke about in prior calls, the catch up, whether it be pent-up demand or the post-merger integration kind of projects and the acquisitions impact on the 27 revenues? And whether or not there's anything similar that we should be considering as we look to 2011?

[Gordon Coburn:]

When you look at the pieces, probably the biggest piece of all of those things that you rattled off is the pent-up demand. That was significant. We had some pretty substantial growth in the second and third quarter in development spend as a result of that. The other items, if you -- as M&A were, clearly had some impact. Acquisitions, PIPC, I think had some impact. Galileo was very small. But the one that really stands out was pent-up demand. But it's very tough to quantify exactly how much that is, because even when we go and ask our CIO was that pent-up demand or current-year projects, it becomes kind of fuzzy. But certainly, it was there.

[Adam Frisch:]

So when you think about '11 and what happened in 2010, how much is the grow over just to get back kind of to par before you grow in excess of that, would you guess?

[Francisco D'Souza:]

I wouldn't want to hazard a guess. it's a very gray area to figure out what falls into which category. But yes, as you said, no question there was pent-up demand that we disproportionately benefited from compared to the rest of the industry in 2010.

[Operator:]

Your next question is from the line of George Price of BB&T Capital Markets.

[George Price:]

Wondering if maybe you could just talk a little bit -- about a little bit more about the expansion in the U.S.? it's kind of interesting to hear about that in terms of hiring new types of people here in the States, expanding facilities here. What's your strategy there? What are you focusing on? Could this have any impact from a margin perspective, either this year or next? Any other impacts to talk about?

[Francisco D'Souza:]

It's Frank, George. So let me give you a quick overview of what we're doing, and some of it is new, other parts of it is stuff that we've been doing for a long time and just expanding. So we continue to build out our delivery footprint in the United States, building delivery centers across the U.S. As Gordon said, we are expanding our Phoenix center which has been in operation for several years now. We're expanding it to accommodate 1,000 people and offer a full range of services. We're actively looking at another center, a new center on the East Coast somewhere, which we will launch sometime during the course of 2011. And that adds to a network of other centers that we have in the United States, really scattered across the country. And we use these centers for a couple of different things. We use them for near-shore capability where work needs to be done close to a client. So some of them are just proximity centers that are very close to big clients. In other cases, we use it for work that cannot, for some reason, be moved outside of the geographic boundaries of the United States for client confidentiality or other reasons. So those are the primary reasons that we build these centers, and we'll continue to do that. That's already in the run rate, it's not new per se. So I don't expect that to have any margin impact at all. The other part of what we're doing new in 2010, 2011, is actively going to U.S. campuses to do hiring. As you know, we've been big recruiters in the United States for years now and in all the countries in which we operate around the world. But we've not had a specific U.S. campus program similar to our India campus program and our China campus program. Now we're going to U.S. universities. We started doing that, as Gordon said, with 15 universities at the undergraduate level in the 2010-2011 cycle, and we expect to expand that again in the 2011-2012 cycle. Again, we don't expect this to have a significant margin impact as these folks will, once we put them through training, will play the on-site roles that we've traditionally staffed with consultants from other parts of the business. So again, it's not a fundamental shift to the model, just looking at different sources of talent for the company.

[George Price:]

Gordon, any thoughts at this point on tax rate as we look out to 2012 given the law changes in India and your growth outlook into tax advantage there as things stand now?

[Gordon Coburn:]

Sure. We're modeling a tax rate in 2012 similar to 2011, right around 25%. In India, the tax rate itself comes down a little bit, and we have one more year of growing more of our business into Special Economic Zones offset by 2011. The higher tax rate from a cash basis is only 3/4 instead of full year. So the way we're modeling is 25% every quarter during 2011, and then also 25% for 2012.

[Operator:]

Your next question is from the line of Jason Kupferberg of UBS.

[Jason Kupferberg:]

When you guys continue to talk about all the run rates you have for growth in terms of new geographies and the verticals and new service finds, where would you peg overall offshore penetration of the global IT services market today versus where you think it can increase to over the long term, just obviously, based on the fact that more and more of the total stack seems to be offshorable?

[Francisco D'Souza:]

It's a very hard question to get an exact fix on. We think that there's, Jason, in the core application development and maintenance market, it's probably about 30% penetrated in core ADM. When you start to go to the other slivers, the other sectors, IT Infrastructure Services, BPO and so on and so forth, we think that's low-single digits, in sort of 5-ish percent range.

[Jason Kupferberg:]

And then are you seeing any of your competitors increasingly trying to emulate your strategy that's worked so well for so long? I mean obviously, it's easier said than done but are you seeing any changes in the marketplace whereby some of your traditional competitors might be trying to hire more domain experts or folks that are onshore versus offshore or any of the elements of your strategy being emulated?

[Gordon Coburn:]

I think there's a recognition that our strategy is what the clients looking for right now, which is a combination of deep domain expertise and strong global delivery. However, I think it's a challenge for many of our competitors given their margin structure that costs money to make the investments in the front end. And there are two strategies out there

[Operator:]

Your next question is from the line of Tim Fox of Deutsche Bank.

[Tim Fox:]

Gordon, when you're looking at the initial guidance for 2011, can you describe the balance between app dev [application development] and maintenance? What are your expectations for that mix for the year at this point?

[Gordon Coburn:]

Sure. So the way to think about it is clearly, we build more conservatism into the app dev side because it is discretionary and we have less visibility on it. So coming into the year, the expectations for development and maintenance growth are probably somewhat similar. And if there's additional opportunities in the year, it's probably more on the app dev side.

[Operator:]

Your next question is from the line of James Friedman of SIG.

[James Friedman:]

I wanted to also follow up with regard to some of the tax rate assumptions. With regard to the taxes, I think people generally understand what's going on with the SEZ's STPIs. I want to ask Gordon though, if you had any observation about this somewhat obscure topic which is in the Indian Income Tax Act and its related to this thing -- I'm speaking Indian but it's deputation in technical manpower, DTM, and specifically the on-site, offshore application? Infosys was hit with this maybe a month ago, another smaller company was hit with it a couple of weeks ago. Could you explain your perspective on this and why it may be different for Cognizant.

[Gordon Coburn:]

Yes. We saw that. The tax authorities are, I guess, exploring with one of our competitors. We've not had any direct involvement other than just watch in case. Don't really have a view on it.

[Operator:]

Your next question is from Glenn Greene of Oppenheimer.

[Glenn Greene:]

I know you're sort of targeting the 19% to 20% operating margin like you have historically, but embedded within there, there's probably some headwinds for wage inflation and rupee appreciation. Could you sort of talk through that a little bit, Gordon?

[Gordon Coburn:]

Sure. So let's start with rupee appreciation. We're in very good shape with our hedging program for this year. We have $780 million of hedges in place at a rate of 48 to one. So not losing a whole lot of sleep over currency other than that there was a very dramatic movement. On wages, clearly, there'll be wage inflation this year. What it'll be will really depend on what our key competitors do, they'll go before us. I think people are going to be restrained and thoughtful in their wage increases and certainly, we will be assuming others in the industry are restrained and thoughtful. So we'll have to watch them play out. But in our margin structure, I'm comfortable that we can handle whatever wage inflation comes to play out. And we'll see what the competitors do in the next eight weeks or so.

[Glenn Greene:]

The proportion of revenue, do you think fixed price will increase as a proportion of revenue in '11?

[Gordon Coburn:]

I think slowly it will. We would like to move more towards the fixed-price model, because obviously, it allows us to do some of the things on breaking linearity between revenue and headcount a bit. I don't think you'll see any dramatic movements though.

[Operator:]

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

[Nabil Elsheshai:]

I was just going to follow up on the pricing. You guys sound a lot more optimistic about price increases in 2011 than some of your competitors. I just wonder if you had any thoughts on why the dichotomy? And if they're less aggressive on pricing, how sustainable or how confident are you that you can put through price increases?

[Gordon Coburn:]

We started going out to customers last April, having discussions about wages are going up, we're delivering value, wages are going up for your own employees, in-house employees. Sure, you'd have the normal pushback but when all's said and done, the general conversations with clients is, "Hey, we don't want a big price increase but we realize you're delivering the value, we realize costs are going up both within our in-house operations and for you, and we understand that it is a modest price increase, is fair and reasonable." And the majority of the clients, that's the how the conversations played out. I can't speak for the competition, but assuming you're delivering the value to the client, to get a low single-digit price increase should not be particularly hard.

[Nabil Elsheshai:]

The expectations for utilization rates in 2011?

[Gordon Coburn:]

Those will bounce around a little bit. The engine got a little too hot, particularly in the third quarter of last year. Obviously, it came down a little bit in Q4. You have some seasonality but overall, somewhere in the same ballpark that we were in Q4 though clearly, it will bounce around quarter-to-quarter.

[Operator:]

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

[Joseph Foresi:]

I was wondering you talked towards the end of last year about some integration work that you were doing in Financial Services. Maybe you could tell us, where we are as far as that work is concerned? And if you expect it to be replaced by the regulatory stuff of the Financial Services group?

[Francisco D'Souza:]

So that work continued through the fourth quarter. There really was one situation that was driving a bulk of that for us, and that continued through the fourth quarter. We expect that, that will slowly taper off through the first quarter and into the second quarter. But we also believe that with the client situation, between the discretionary spending and some other work that's there, we should be able to replace that M&A work that's going away. As to specifically the regulatory work, I don't have a good clear sense of when that's going to come online because candidly, a lot depends on when the regs get written and how those regs play out. So I'm not specifically counting on regulatory reform work to fill that gap. But I feel like with the discretionary spending and other visibility that we have, we can make that up.

[Joseph Foresi:]

How would you characterize the pipeline this year versus last year?

[Francisco D'Souza:]

I think our pipeline is strong going into the year. As Gordon said, discretionary spending looks good. We think that budgets are in a normal cycle. Our clients are towards the tail end of finalizing their budgets. Budgets have a modest upside bias and what's most important here is that we see that the recession served as a catalyst for a significant share shift to an offshore model. And so based on that, our pipeline is strong across service offerings and across our business, we feel good going into 2011.

[Operator:]

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

[Joseph Vafi:]

We've heard a lot about how much IT budgets are going to be up in 2011. Maybe Frank, maybe Gordon, do you have -- and I know, Frank, you talked a little bit about wallet share going up, do you got a -- after talking to your clients, do you care to throw out a number of how much you think offshore wallet share may rise across the board here in 2011?

[Francisco D'Souza:]

Like I said to an earlier question, I think that the issue here is when we look at the core ADM market, we think it's about 30% penetrated. I think that, that over time will go up quite significantly. I'm not sure it ever gets to 100% because of perhaps regulatory reasons and so on, so some things can't move out of the United States, out of the geographic areas, U.S. and Europe and other places. But I think that will be up pretty high. IT, IS and BPO, low-single digits right now. I think that, that can move up 30% in the next five years. We see NASSCOM's projection for growth for the next year is 16% to 18% across IT and BPO. So we think that, that's a reasonable proxy for the opportunity that, that represents for the overall industry.

[Operator:]

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

[Mayank Tandon:]

Gordon, you've talked about the run rate opportunity within your top clients. Maybe give us a sense, if you can, about where that beneficial level was say in your top 20, top 30 clients pre-recession and then where that stands today, just to give us a better sense of what the run rate of today versus pre-recession?

[Gordon Coburn:]

I'm not sure if the penetration rates have changed a whole lot even though we're getting more revenue from them. The primary reason for this is the recession served as a catalyst for clients to look at how do they want to use offshore and global delivery both more deeply. So do more things similar to what they're already doing offshore as well as broadly. So new service offerings. Therefore, the addressable market or the slice of the pie that we're eligible for at our larger clients has expanded. You net those two things out, that against the growth and revenue we've had over the last two years. I'm not sure penetration rates have moved a whole lot.

[Mayank Tandon:]

Outcome-based pricing, a lot of your peers are talking about that. Is that the same thing as fixed price or is that different in your mind? And if it is different, what is that percentage for you relative to your overall pricing?

[Gordon Coburn:]

There's lot of semantics on that. I view it as largely different. I view fixed price as we agree to build a system and we charge you x dollars, no matter how much time it takes. Versus outcome-based pricing may be more based on, "Okay, we can build the system that results in productivity improvements for your operations, and we'll get paid and rewarded based on what productivity gains you actually capture." So the benefits of the system rather than just delivering the system for a fixed cost. True outcome-based pricing is a very small piece of our portfolio today. I think over time, it'll grow. But today, the vast majority of the fixed-price revenue is true fixed price, where there's a system that's spec-ed out and we quote a specific price to deliver it. But it will evolve overtime and you'll see more outcome-based pricing and certainly more transaction-based pricing.

[Francisco D'Souza:]

Good. I think we're just about at 10

[Operator:]

This concludes Cognizant's Fourth Quarter and Full Year 2010 Results Conference Call. You may now disconnect.