UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington , D.C. 20549
 
FORM 6-K
 
Report of Foreign Private Issuer
Pursuant to Rule 13a-16 or 15d-16 of the Securities Exchange Act of 1934
 
For the quarter ended December 31, 2005
Commission File Number: 000-25383
 
INFOSYS TECHNOLOGIES LIMITED
(Exact name of Registrant as specified in its charter)
 
Not Applicable
(Translation of Registrant's name into English)
 
Bangalore , Karnataka, India
(Jurisdiction of incorporation or organization)
 
Electronics City, Hosur Road, Bangalore, Karnataka, India 560 100. 80-2852-0261
(Address of principal executive offices)
 
Indicate by check mark registrant files or will file annual reports under cover Form 20-F or Form 40-F.
Form 20-F x Form 40-F o
 
Indicate by check mark whether the registrant by furnishing the information contained in this Form is also thereby furnishing the information to the Commission pursuant to Rule 12g 3-2(b) under the Securities Exchange Act of 1934
Yes o No x
 
If "Yes" is marked, indicate below the file number assigned to registrant in connection with Rule 12g 3-2(b).
Not Applicable

Currency of Presentation and Certain Defined Terms

In this Quarterly Report, references to " U.S." or " United States" are to the United States of America, its territories and its possessions. References to " India" are to the Republic of India. References to "$" or "dollars" or "U.S. dollars" are to the legal currency of the United States and references to "Rs." or "rupees" or "Indian rupees" are to the legal currency of India. Our financial statements are presented in Indian rupees and translated into U.S. dollars and are prepared in accordance with United States Generally Accepted Accounting Principles, or U.S. GAAP. References to "Indian GAAP" are to Indian Generally Accepted Accounting Principles. References to a particular "fiscal" year are to our fiscal year ended March 31 of such year.

All references to "we," "us," "our," "Infosys" or the "Company" shall mean Infosys Technologies Limited, and, unless specifically indicated otherwise or the context indicates otherwise, our consolidated subsidiaries. "Infosys" is a registered trademark of Infosys Technologies Limited in the United States and India. All other trademarks or tradenames used in this Quarterly Report are the property of their respective owners.

Except as otherwise stated in this Quarterly Report, all translations from Indian Rupees to U.S. dollars are based on the noon buying rate in the City of New York on December 30, 2005, for cable transfers in Indian rupees as certified for customs purposes by the Federal Reserve Bank of New York which was Rs.44.95 per $1.00. December 30, 2005 was the last day of the quarter ended December 31, 2005 for which the noon buying rate is available. No representation is made that the Indian rupee amounts have been, could have been or could be converted into U.S. dollars at such a rate or any other rate. Any discrepancies in any table between totals and sums of the amounts listed are due to rounding. Information contained in our website, www.infosys.com, is not part of this Quarterly Report.

Forward-Looking Statements May Prove Inaccurate

In addition to historical information, this Quarterly Report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The forward-looking statements contained herein are subject to certain risks and uncertainties that could cause actual results to differ materially from those reflected in the forward-looking statements. Factors that might cause such differences include but are not limited to, those discussed in the section entitled "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this Report. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis only as of the date of this Report. In addition, readers should carefully review the other information in this Quarterly Report and in the Company's periodic reports and other documents filed with the Securities and Exchange Commission ("SEC") from time to time.

TABLE OF CONTENTS

Part I - Financial Information

Item 1. Financial Statements

Consolidated Balance Sheets
Unaudited Consolidated Statements of Income
Unaudited Consolidated Statements of Stockholders' Equity and Comprehensive Income
Unaudited Consolidated Statements of Cash Flows
Notes to the Unaudited Consolidated Financial Statements

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosure about Market Risk
Item 4. Controls and Procedures

Part II - Other Information

Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Changes in Securities and Use of Proceeds
Item 3. Default upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports

SIGNATURES
EXHIBIT INDEX
EXHIBIT 31.1
EXHIBIT 32.1

Part I - Financial Information
Item 1. Financial Statements

(Dollars in millions except share and per share data)

As of

March 31, 2005 (1)

December 31, 2005

(Unaudited)

ASSETS

Current Assets

Cash and cash equivalents

$

410

$

477

Investment in liquid mutual fund units

278

492

Trade accounts receivable, net of allowances

303

310

Deferred tax assets

2 

2

Prepaid expenses and other current assets

35

39

Unbilled revenue

32

35

Total current assets

1,060

1,355

Property, plant and equipment, net

352

457

Goodwill

8

8

Deferred tax assets

8

11

Other assets

26

31

Total Assets

$

1,454

$

1,862

LIABILITIES AND STOCKHOLDERS' EQUITY

Current Liabilities

Accounts payable

$

1

$

2

Client deposits

7

3

Other accrued liabilities

124

140

Deferred tax liabilities

-

1

Income taxes payable

23

17

Unearned revenue

20

42

Total current liabilities

175

205

Non-current liabilities

Preferred stock of subsidiary

21

-

Other non-current liabilities

5

5

Minority interests

-

13

Stockholders' Equity

Common stock, $0.16 par value 300,000,000 equity shares authorized, Issued and outstanding - 270,570,549 and 274,525,163 equity shares as of March 31, 2005 and December 31, 2005 respectively

31

31

Additional paid-in capital

266

379

Accumulated other comprehensive income

33

(6)

Retained earnings

923

1,235

Total stockholders' equity

1,253

1,639

Total Liabilities and Stockholders' Equity

$

1,454

$

1,862

(1) March 31, 2005 balances were obtained from audited financial statements
See accompanying notes to the unaudited consolidated financial statements

INFOSYS TECHNOLOGIES LIMITED AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME

 (Dollars in millions except share and per share data)

Three months ended December 31,

Nine months ended December 31,

2004

2005

2004

2005

Revenues

$

423

$

559

$

1,137

$

1,559

Cost of revenues

241

319

642

890

Gross profit

182

240

495

669

Operating Expenses:

Selling and marketing expenses

26

35

76

102

General and administrative expenses

34

41

91

124

Amortization of intangible assets

-

-

1

-

Total operating expenses

60

76

168

226

Operating income

122

164

327

443

Other income, net

11

(1)

17

15

Income before income taxes and minority interest

133

163

344

458

Provision for income taxes

21

18

52

52

Income before minority interest

112

145

292

406

Minority interest

-

2

-

3

Net income

$

112

143

292

403

Earnings per equity share

Basic

$

0.42

$

0.53

$

1.09

$

1.49

Diluted

$

0.40

$

0.51

$

1.07

$

1.44

Weighted average equity shares used in computing earnings per equity share

Basic

267,360,142

272,357,876

266,307,767

270,875,779

Diluted

275,372,238

279,912,922

272,581,961

278,434,381

See accompanying notes to the unaudited consolidated financial statements

(Dollars in millions)

Common stock

Additional paid-in capital

Comprehensive income

Accumulated other comprehensive income

Retained earnings

Total stockholders' equity

Shares

Par value

Balance as of March 31, 2004

266,564,224

$

9

$

157

$

39

$

748

$

953

Common stock issued

2,892,080

-

67

-

-

67

Cash dividends

-

-

-

-

(222)

(222)

Income tax benefit arising on exercise of stock options

-

-

4

-

-

4

Stock split effected in the form of a stock dividend

-

22

-

-

(22)

-

Comprehensive income

Net income

-

-

-

$

292

-

292

292

Other comprehensive income

Translation adjustment

-

-

-

3

3

-

3

Comprehensive income

$

295

Balance as of December 31, 2004

269,456,304

$

31

$

228

$

42

$

796

$

1,097

Balance as of March 31, 2005

270,570,549

$

31

$

266

$

33

$

923

$

1,253

Common stock issued

3,954,614

-

101

-

-

101

Cash dividends

-

-

-

-

(91)

(91)

Change in proportionate share of subsidiary resulting from issuance of stock by subsidiary

-

-

12

-

-

12

Comprehensive income

Net income

-

-

-

$

403

-

403

403

Other comprehensive income

Unrealized gain on mutual fund investments, net of taxes

-

-

-

1

1

-

1

Translation adjustment

-

-

-

(40)

(40)

-

(40)

Comprehensive income

$

364

Balance as of December 31, 2005

274,525,163

$

31

$

379

$

(6)

$

1,235

$

1,639

See accompanying notes to the unaudited consolidated financial statements

INFOSYS TECHNOLOGIES LIMITED AND SUBSIDIARIES
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in millions)

Nine months ended
December 31,

Operating Activities:

2004

2005

Net income

$

292

$

403

Adjustments to reconcile net income to net cash provided by operating activities

Depreciation and amortization

42

66

Deferred taxes

(3)

(2)

Changes in assets and liabilities

Trade accounts receivable

(85)

(16)

Prepaid expenses and other current assets

(1)

(2)

Unbilled revenue

(5)

(4)

Income taxes

11

(3)

Accounts payable

-

2

Client deposits

(7)

(4)

Unearned revenue

11

23

Other accrued liabilities

13

20

Net cash provided by operating activities

268

 486 

Investing Activities:

Expenditure on property, plant and equipment

(130)

(184)

Loans to employees

1

 (1)

Non-current deposits placed with corporations

(11)

(9)

Withdrawal of non-current deposits with corporations

-

1

Investment in liquid mutual fund units

(56)

(418)

Redemption of liquid mutual fund units

32

193

Net cash used in investing activities

(164)

(418)

Financing Activities:

Proceeds from issuance of common stock

67

101

Payment of dividends

(222)

(91)

Net cash (used in)/provided by financing activities

(155)

10

Effect of exchange rate changes on cash

(5)

(11)

Net increase / (decrease) in cash and cash equivalents during the period

(56)

67

Cash and cash equivalents at the beginning of the period

445

410

Cash and cash equivalents at the end of the period

$

389

$

 477

Supplementary information:

Cash paid towards taxes

$

43

$

58

INFOSYS TECHNOLOGIES LIMITED AND SUBSIDIARIES

NOTES TO THE UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1. Company overview and significant accounting policies

1.1 Company overview

Infosys Technologies Limited (Infosys), along with its majority owned and controlled subsidiary, Progeon Limited (Progeon), and wholly-owned subsidiaries Infosys Technologies (Australia) Pty. Limited (Infosys Australia), Infosys Technologies ( Shanghai) Co. Limited (Infosys China) and Infosys Consulting Inc. (Infosys Consulting) is a leading global technology services firm. The company provides end-to-end business solutions that leverage technology thus enabling its clients to enhance business performance. The company provides solutions that span the entire software life cycle encompassing consulting, design, development, software re-engineering, maintenance, systems integration, package evaluation and implementation and infrastructure management services. In addition, the company offers software products for the banking industry and business process management services.

1.2 Basis of preparation of financial statements

The consolidated financial statements include Infosys and its subsidiaries (the company) and are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). Infosys consolidates entities in which it owns or controls more than 50% of the voting shares. The results of acquired businesses are included in the consolidated financial statements from the date of acquisition. Inter-company balances and transactions are eliminated on consolidation. Changes in the proportionate share of Infosys in the equity of subsidiaries resulting from additional equity issued by the subsidiaries are accounted for as an equity transaction in consolidation.

Interim information presented in the consolidated financial statements has been prepared by the management without audit and, in the opinion of management, includes all adjustments of a normal recurring nature that are necessary for the fair presentation of the financial position, results of operations and cash flows for the periods shown, and is in accordance with GAAP. These financial statements should be read in conjunction with the consolidated financial statements and related notes included in the company's annual report on Form 20-F for the fiscal year ended March 31, 2005.

1.3 Use of estimates

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities, the disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates and assumptions are used for, but not limited to, accounting for costs and efforts expected to be incurred to complete performance under software development arrangements, allowance for uncollectible accounts receivable, future obligations under employee benefit plans, provisions for post-sales customer support, the useful lives of property, plant, equipment and intangible assets and income tax valuation allowances. Actual results could differ from those estimates. Appropriate changes in estimates are made as management become aware of changes in circumstances surrounding the estimates. Changes in estimates are reflected in the financial statements in the period in which changes are made and, if material, their effects are disclosed in the notes to the consolidated financial statements.

1.4 Revenue recognition

The company derives revenues primarily from software development and related services, licensing of software products and from business process management services. Arrangements with customers for software development and related services are either on a fixed-price, fixed-timeframe or on a time-and-material basis.

Revenue on time-and-material contracts is recognized as the related services are performed and revenue from the end of the last billing to the balance sheet date is recognized as unbilled revenues. Revenue from fixed-price, fixed-timeframe contracts is recognized as per the percentage-of-completion method. Guidance has been drawn from paragraph 95 of Statement of Position (SOP) 97-2, Software Revenue Recognition, to account for revenue from fixed price arrangements for software development and related services in conformity with SOP 81-1. The input (efforts expended) method has been used to measure progress towards completion as there is a direct relationship between input and productivity. Provisions for estimated losses, if any, on uncompleted contracts are recorded in the period in which such losses become probable based on the current contract estimates. Costs and earnings in excess of billings are classified as unbilled revenue while billings in excess of costs and earnings are classified as unearned revenue. Maintenance revenue is recognized ratably over the term of the underlying maintenance agreement.

The company provides its clients with a fixed-period warranty for corrections of errors and telephone support on all its fixed-price, fixed-timeframe contracts. Costs associated with such support services are accrued at the time related revenues are recorded and included in cost of revenues. The company estimates such costs based on historical experience and estimates are reviewed on a periodic basis for any material changes in assumptions and likelihood of occurrence.

In accordance with SOP 97-2, license fee revenues are recognized when persuasive evidence of an arrangement exists, delivery has occurred, the license fee is fixed and determinable, and the collection of the fee is probable. Arrangements to deliver software products generally have three elements: license, implementation and Annual Technical Services (ATS). The company has applied the principles in SOP 97-2 to account for revenue from these multiple element arrangements. Vendor specific objective evidence of fair value (VSOE) has been established for ATS. VSOE is the price charged when the element is sold separately. When other services are provided in conjunction with the licensing arrangement, the revenue from such contracts are allocated to each component of the contract using the residual method, whereby revenue is deferred for the undelivered services and the residual amounts are recognized as revenue for delivered elements. In the absence of an established VSOE for implementation, the entire arrangement fee for license and implementation is recognized as the implementation is performed. Revenue from client training, support and other services arising due to the sale of software products is recognized as the services are performed. ATS revenue is recognized ratably over the period in which the services are rendered.

Revenues from business process management and other services are recognized on both, the time-and-material and fixed-price, fixed-timeframe basis. Revenue on time-and-material contracts is recognized as the related services are rendered. Revenue from fixed-price, fixed-timeframe contracts is recognized as per the proportional performance method using an output measure of performance.

When the company receives advances for services and products, such amounts are reported as client deposits until all conditions for revenue recognition are met.

1.5 Cash and cash equivalents

The company considers all highly liquid investments with a remaining maturity at the date of purchase / investment of three months or less and that are readily convertible to known amounts of cash to be cash equivalents. Cash and cash equivalents comprise cash and cash on deposit with banks, and corporations.

1.6 Investments

Investments in non-readily marketable equity securities of other entities where the company is unable to exercise significant influence and for which there are no readily determinable fair values are recorded at cost. Declines in value judged to be other than temporary are included in earnings.

Investment securities designated as "available for sale" are carried at their fair value. Fair value is based on quoted market prices. Temporary unrealized gains and losses, net of the related tax effect are reported as a separate component of stockholders' equity until realized. Realized gains and losses and declines in value judged to be other than temporary on available for sale securities are included in earnings.

The cost of securities sold is based on the specific identification method. Interest and dividend income are recognized when earned.

1.7 Property, plant and equipment

Buildings

15 years

Vehicles

5 years

Plant and equipment

5 years

Computer equipment

2-5 years

Furniture and fixtures

5 years

The cost of software purchased for internal use is accounted under SOP 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. Deposits paid towards the acquisition of these long lived assets outstanding at each balance sheet date and the cost of assets not put to use before such date are disclosed under "Capital work-in-progress". Costs of improvements that substantially extend the useful life of particular assets are capitalized. Repairs and maintenance cost are charged to earnings when incurred. The cost and related accumulated depreciation are removed from the consolidated financial statements upon sale or disposition of the asset.

The company evaluates the recoverability of these assets whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying value of the assets exceeds the fair value of the assets. Assets to be disposed are reported at the lower of the carrying value or the fair value less the cost to sell.

1.8 Business combinations

Business combinations have been accounted using the purchase method under the provisions of Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standard (SFAS) No. 141, Business Combinations. Cash and amounts of consideration that are determinable at the date of acquisition are included in determining the cost of the acquired business.

1.9 Goodwill

Goodwill represents the cost of the acquired businesses in excess of the fair value of identifiable tangible and intangible net assets purchased. Goodwill is tested for impairment on an annual basis, relying on a number of factors including operating results, business plans and future cash flows. Recoverability of goodwill is evaluated using a two-step process. The first step involves a comparison of the fair value of a reporting unit with its carrying value. If the carrying amount of the reporting unit exceeds its fair value, the second step of the process involves a comparison of the fair value and carrying value of the goodwill of that reporting unit. If the carrying value of the goodwill of a reporting unit exceeds the fair value of that goodwill, an impairment loss is recognized in an amount equal to the excess. Goodwill of a reporting unit is tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount.

1.10 Intangible assets

Intangible assets are amortized over their respective individual estimated useful lives on a straight-line basis. The estimated useful life of an identifiable intangible asset is based on a number of factors including the effects of obsolescence, demand, competition, and other economic factors (such as the stability of the industry, and known technological advances), and the level of maintenance expenditures required to obtain the expected future cash flows from the asset.

Intangible assets are evaluated for recoverability whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying value of the assets exceeds the fair value of the assets.

1.11 Research and development

Research and development costs are expensed as incurred. Software product development costs are expensed as incurred until technological feasibility is achieved. Research and development costs and software development costs incurred under contractual arrangements with customers are accounted as cost of revenues.

1.12 Foreign currency

The functional currency of the company is the Indian rupee (Rs.). The functional currency for Infosys Australia, Infosys China and Infosys Consulting is the respective local currency. The consolidated financial statements are reported in U.S. dollars. The translation of Rs. to U.S. dollars is performed for balance sheet accounts using the exchange rate in effect at the balance sheet date and for revenue, expense and cash-flow items using a monthly average exchange rate for the respective periods. The gains or losses resulting from such translation are included in "Other comprehensive income", a separate component of stockholders' equity. The translation of the financial statements of foreign subsidiaries from the local currency to the functional currency of the company is also performed on the same basis.

Foreign-currency denominated assets and liabilities are translated into the functional currency at exchange rates in effect at the balance sheet date. The gains or losses resulting from such translation are included in earnings. Transaction gains or losses realized upon settlement of foreign currency transactions are included in determining net income for the period in which the transaction is settled. Revenue, expense and cash-flow items denominated in foreign currencies are translated into the functional currency using the exchange rate in effect on the date of the transaction.

1.13 Earnings per share

Basic earnings per share is computed by dividing net income for the period by the weighted average number of equity shares outstanding during the period. Diluted earnings per share is computed by dividing net income by the diluted weighted average number of equity shares outstanding during the period. Diluted earnings per share reflects the potential dilution from equity shares issuable through employee stock options and preferred stock of subsidiary. The dilutive effect of employee stock options is reflected in diluted earnings per share by application of the treasury stock method. The dilutive effect of convertible securities is reflected in diluted earnings per share by application of the if-converted method. If securities have been issued by a subsidiary that enable their holders to obtain the subsidiary's common stock, the earnings of the subsidiary shall be included in the consolidated diluted earnings per share computations based on the consolidated group's holding of the subsidiary's securities.

If the number of common shares outstanding increases as a result of a stock dividend or stock split or decreases as a result of a reverse stock split, the computations of basic and diluted earnings per share are adjusted retroactively for all periods presented to reflect that change in capital structure. If such changes occur after the close of the reporting period but before issuance of the financial statements, the per-share computations for that period and any prior-period financial statements presented are based on the new number of shares.

1.14 Income taxes

Income taxes are accounted using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities, and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of changes in tax rates on deferred tax assets and liabilities is recognized in the period that includes the enactment date. The measurement of deferred tax assets is reduced, if necessary, by a valuation allowance for any tax benefits of which future realization is not more likely than not. Changes in valuation allowance from period to period are reflected in the income statement of the period of change. Deferred taxes are not provided on the undistributed earnings of subsidiaries outside India where it is expected that the earnings of the foreign subsidiary will be permanently reinvested. Tax benefits of deductions earned on exercise of employee stock options in excess of compensation charged to earnings are credited to additional paid in capital. The income tax provision for the interim period is based on the best estimate of the effective tax rate expected to be applicable for the full fiscal year.

1.15 Fair value of financial instruments

In determining the fair value of its financial instruments, the company uses a variety of methods and assumptions that are based on market conditions and risks existing at each balance sheet date. The methods used to determine fair value include discounted cash flow analysis and dealer quotes. All methods of assessing fair value result in general approximation of value, and such value may never actually be realized.

1.16 Concentration of risk

Financial instruments that potentially subject the company to concentrations of credit risk consist principally of cash equivalents, trade accounts receivable, investment securities and hedging instruments. By nature, all such financial instruments involve risk, including the credit risk of non-performance by counterparties. In management's opinion, as of March 31, 2005 and December 31, 2005 there was no significant risk of loss in the event of non-performance of the counterparties to these financial instruments, other than the amounts already provided for in the financial statements, if any. Exposure to credit risk is managed through credit approvals, establishing credit limits and monitoring procedures. The company's cash resources are invested with corporations, financial institutions and banks with high investment grade credit ratings. Limits are established by the company as to the maximum amount of cash that may be invested with any such single entity.

1.17 Derivative financial instruments

The company uses derivative financial instruments such as foreign exchange forward and option contracts to mitigate the risk of changes in foreign exchange rates on accounts receivable and forecasted cash flows denominated in certain foreign currencies. The counterparty for these contracts is generally a bank. Although the company believes that these financial instruments constitute hedges from an economic perspective, they do not qualify for hedge accounting under SFAS 133, as amended. Any derivative that is either not designated a hedge, or is so designated but is ineffective per SFAS 133, is marked to market and recognized in earnings immediately.

1.18 Retirement benefits to employees

1.18.1 Gratuity

In accordance with the Payment of Gratuity Act, 1972, Infosys provides for gratuity, a defined benefit retirement plan (the Gratuity Plan) covering eligible employees. The Gratuity Plan provides a lump-sum payment to vested employees at retirement, death, incapacitation or termination of employment, of an amount based on the respective employee's salary and the tenure of employment.

Liabilities with regard to the Gratuity Plan are determined by actuarial valuation. The company fully contributes all ascertained liabilities to the Infosys Technologies Limited Employees' Gratuity Fund Trust (the Trust). In case of Progeon, contributions are made to the Progeon Employees' Gratuity Fund Trust. Trustees administer contributions made to the Trust and contributions are invested in specific designated instruments as permitted by law and investments are also made in mutual funds that invest in the specific designated instruments.

1.18.2 Superannuation

Certain employees of Infosys are also participants in a defined contribution plan. Till March 2005, the company made monthly contributions under the superannuation plan (the Plan) to the Infosys Technologies Limited Employees' Superannuation Fund Trust based on a specified percentage of each covered employee's salary. The company had no further obligations to the Plan beyond its monthly contributions. Certain employees of Progeon were also eligible for superannuation benefit. Progeon made monthly provisions under the superannuation plan based on a specified percentage of each covered employee's salary. Progeon had no further obligations to the superannuation plan beyond its monthly provisions which are periodically contributed to a trust fund, the corpus of which is invested with the Life Insurance Corporation of India. From April 1, 2005, a substantial portion of the monthly contribution amount is paid directly to the employees as an allowance and a nominal amount i s contributed to the trusts.

1.18.3 Provident fund

Eligible employees of Infosys receive benefits from a provident fund, which is a defined contribution plan. Both the employee and the company make monthly contributions to the provident fund plan equal to a specified percentage of the covered employee's salary. The company contributes a part of the contributions to the Infosys Technologies Limited Employees' Provident Fund Trust. The remaining portion is contributed to the government administered pension fund. The rate at which the annual interest is payable to the beneficiaries by the trust is being administered by the government. The company has an obligation to fund any shortfall on the yield of the trust's investments over the administered interest rates.

In respect of Progeon, eligible employees receive benefits from a provident fund, which is a defined contribution plan. Both the employee and Progeon make monthly contributions to this provident fund plan equal to a specified percentage of the covered employee's salary. Amounts collected under the provident fund plan are deposited in a government administered provident fund.

1.19 Stock-based compensation

The company applies the intrinsic value-based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations including FASB Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation an interpretation of APB Opinion No. 25, issued in March 2000, to account for its fixed stock option plans. Under this method, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeds the exercise price. SFAS 123, Accounting for Stock-Based Compensation, established accounting and disclosure requirements using a fair value-based method of accounting for stock-based employee compensation plans. As allowed by SFAS 123, the Company has elected to continue to apply the intrinsic value-based method of accounting described above, and has adopted the disclosure requirements of SFAS 148, Accounting for Stock-Based Compensation - Transition and Disclosure, an amendment of FASB Statement No. 123. All stock options issued to date have been accounted as a fixed stock option plan.

(Dollars in millions except per share data)

Nine months ended  December 31,

2004

2005

Net income, as reported

$

292

$

403

Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects

(22)

(9)

Pro forma net income

$

270

$

394

Earnings per share:

Basic - as reported

$

1.09

$

1.49

Basic - pro forma

$

1.01

$

1.45

Diluted - as reported

$

1.07

$

1.44

Diluted - proforma

$

0.99

$

1.41

There have been no grants of stock options by Infosys Technologies Limited during the nine months ended December 31, 2004 and 2005.

1.20 Dividends

Final dividends on equity shares are recorded as a liability on the date of declaration by the stockholders and interim dividends are recorded as a liability on the date of declaration by the board of directors.

1.21 Recent Accounting Pronouncements

In December 2004, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 123 (revised 2004), Share-Based Payment, requiring companies to change their accounting policies to record the fair value of stock options issued to employees as an expense. Currently, the company does not deduct the expense of employee stock option grants from its income based on the fair value method as it has adopted the pro forma disclosure provisions of SFAS No. 123, Accounting for Stock-Based Compensation. The revised Statement eliminates the alternative to use APB Opinion 25's intrinsic value method of accounting that was provided in Statement 123 as originally issued. The unamortized stock compensation expense as of December 31, 2005, determined under the fair value method is approximately $6 million. Pursuant to the Securities and Exchange Commission Release No. 33-8568, the company is required to adopt SFAS 123R from April 1, 2006.

2. Notes to the consolidated financial statements

2.1 Cash and cash equivalents

The cost and fair values for cash and cash equivalents are as follows:

(Dollars in millions)

As of

March 31, 2005

December 31, 2005

Cost and fair values

Cash and bank deposits

$

361

$

377

Deposits with corporations

49

100

$

410

$

477

Cash and cash equivalents include restricted cash balances in the amount of $1 million as of December 31, 2005. The restrictions are primarily on account of accrued dividends.

2.2 Trade accounts receivable

Trade accounts receivable as of March 31, 2005 and December 31, 2005, net of allowance for doubtful accounts of $4 million and $2 million respectively, amounted to $303 million and $310 million. The age profile of trade accounts receivable, net of allowances is given below.

In %

As of

March 31, 2005

December 31, 2005

Period (in days)

0 - 30

55.2

62.6

31 - 60

32.2

27.6

61 - 90

4.6

6.5

More than 90

8.0

3.3

100.0

100.0

2.3 Business combination

On January 2, 2004 the company acquired, for cash, 100% of the equity in Expert Information Services Pty. Limited, Australia for $14 million. The purchase consideration includes $3 million retained in escrow for representations and warranties made by the selling shareholders. The acquired company was renamed "Infosys Technologies (Australia) Pty. Limited". There is further contingent consideration payable to the sellers subject to continued employment and meeting of defined operating and financial performance parameters. The contingent consideration is being accounted as compensation.

The purchase price, including transaction costs, has been allocated based on management's estimates and independent appraisals of fair values as follows:

(Dollars in millions)

Component

Purchase price allocated

Plant and equipment

$

1 

Net current assets

5 

Non current liabilities

(1)

Customer contracts

2 

Goodwill

7 

Total purchase price

$

14

The identified customer contracts intangible was amortized over a period of two years beginning January 2004, being management's estimate of the useful life of the asset. The company believes that the acquisition resulted in recognition of goodwill primarily because of the acquired company's market position, skilled employees, management strength and potential to serve as a platform for enhancing business opportunities in Australia. The goodwill has been allocated to the Australia reporting unit.

(Dollars in millions)

As of

March 31, 2005

December 31, 2005

Rent deposits

$

4

$

3

Security deposits with service providers

4

4

Loans to employees

15

17

Prepaid expenses

11

15

1 

- 

$

35

$

39

Prepaid expenses as of December 31, 2005 include $6 million advanced to the Infosys Technologies Limited Employees' Gratuity Fund Trust and Infosys Technologies Limited Employees' Provident Fund Trust. Other current assets represent advance payments to vendors for the supply of goods and rendering of services and marked to market gains on foreign exchange forward contracts. Deposits with service providers relate principally to leased telephone lines and electricity supplies.

2.5 Property, plant and equipment - net

Property, plant and equipment consist of the following:

(Dollars in millions)

As of

March 31, 2005

December 31, 2005

Land

$

27 

$

29 

Buildings

168 

222 

Furniture and fixtures

79 

95 

Computer equipment

141 

172 

Plant and equipment

91 

123 

Capital work-in-progress

73 

99 

579

740

Accumulated depreciation

(227)

(283)

352

457

Depreciation expense amounted to $41 million and $66 million for the nine months ended December 31, 2004 and 2005 respectively. The amount of third party software (for internal use) expensed during the nine months ended December 31, 2004 and 2005 was $ 18 million and $23 million respectively.

2.6 Other assets

Other assets consist of the following:

(Dollars in millions)

As of

March 31, 2005

December 31, 2005

Non current portion of loans to employees

$

10

$

8

Non current deposits with corporations

15

23

Others

1

-

$

26

$

31

2.7 Related parties

The company provides loans to eligible employees in accordance with policy. No loans have been made to employees in connection with equity issues. The employee loans are repayable over fixed periods ranging from 1 to 100 months. The annual rates of interest at which the loans have been made to employees vary between 0% through 4%. Loans aggregating $25 million were outstanding as of March 31, 2005 and December 31, 2005. The estimated fair values of related party receivables amounted to $21 million as of March 31, 2005 and December 31, 2005. These amounts have been determined using available market information and appropriate valuation methodologies. Considerable judgment is required to develop these estimates of fair value. Consequently, these estimates are not necessarily indicative of the amounts that the company could realize in the market.

The required repayments of employee loans outstanding as of December 31, 2005 are as detailed below.

(Dollars in millions)

Twelve months ending December 31,

$

2006

17

2007

4

2008

2

2009

1

2010

1

$

25

2.8 Other accrued liabilities

Other accrued liabilities comprise the following:

(Dollars in millions)

As of

March 31, 2005

December 31, 2005

Accrued compensation to staff

$

66

$

62

Accrued dividends

-

1

Provision for post sales client support

7

3

Withholding taxes payable

14

22

Provision for expenses

32

46

Retainage

3

3

Others

2

3 

124

140

2.9 Employee post-retirement benefits

2.9.1 Gratuity

Net gratuity cost was $4 million and $6 million for the nine months ended December 31, 2004 and 2005. The significant component of net gratuity cost is service cost of approximately $4 million and $6 million for the nine months ended December 31, 2004 and 2005. Interest cost and expected return on assets was $1 million each for the nine months ended December 31, 2004. Interest cost and expected return on assets was $2 million each for the nine months ended December 31, 2005.

The company had previously disclosed in the financial statements for the year ended March 31, 2005 that the company expects to contribute approximately $7 million to the gratuity trusts during fiscal 2006. As of December 31, 2005, $6 million of contributions have been made. Company presently anticipates contributing additional $2 million to the gratuity trusts in fiscal 2006 for a total of $8 million.

2.9.2 Superannuation

The company contributed $3 million to the superannuation plan during the nine months ended December 31, 2004. From April 1, 2005, a substantial portion of the monthly contribution amount has been paid directly to the employees as an allowance and a nominal amount has been contributed to the plan.

2.9.3 Provident fund

The company contributed $7 million and $11 million to the provident fund during the nine months ended December 31, 2004 and 2005.

2.10 Stockholders' equity

Infosys has only one class of capital stock referred to as equity shares. On June 12, 2004, the members of the company approved a 3:1 bonus issue on the equity shares of the company. The bonus issue has the nature of a stock split effected in the form of a stock dividend with three additional shares being issued for every share held. Bonus shares have been allotted to shareholders on July 3, 2004. The computations of basic and diluted earnings per share has been adjusted retroactively for all periods presented to reflect the change in capital structure. All references in these financial statements to number of shares, per share amounts and exercise price of stock option grants are retroactively restated to reflect stock splits made.

The rights of equity shareholders are set out below.

2.10.1 Voting

Each holder of equity shares is entitled to one vote per share. The equity shares represented by American Depositary Shares (ADS) carry similar rights to voting and dividends as the other equity shares. Each ADS represents one underlying equity share.

2.10.2 Dividends

Should the company declare and pay dividends, such dividends will be paid in Indian Rupees. Indian law mandates that any dividend be declared out of distributable profits only after the transfer of a specified percentage of net income computed in accordance with current regulations to a general reserve. Moreover, the remittance of dividends outside India is governed by Indian law on foreign exchange and is subject to applicable taxes.

2.10.3 Liquidation

In the event of liquidation of the company, the holders of common stock shall be entitled to receive any of the remaining assets of the company, after distribution of all preferential amounts. The amounts will be in proportion to the number of equity shares held by the stockholders.

2.10.4 Stock options

There are no voting, dividend or liquidation rights to the holders of options issued under the company's stock option plans.

2.11 Preferred stock of subsidiary

Infosys holds a majority of the equity share capital of Progeon. The equity shares have been issued to Infosys as per the terms of the stock subscription agreement signed in April 2002, between Infosys, Citicorp International Finance Corporation (CIFC) and Progeon. 12,250,000 equity shares have been issued to Infosys in each of April 2002 and March 2004 for an aggregate consideration approximating $5 million. Pursuant to the agreement, CIFC was issued 4,375,000 (0.0005%) cumulative convertible preference shares in each of June 2002 and March 2004 for an aggregate consideration approximating $20 million.

The stock subscription agreement provided that unless earlier converted pursuant to an agreement in this behalf between the company and CIFC, these cumulative convertible preference shares shall automatically be converted into equity shares upon the earlier of, (i) one year prior to Progeon's initial public offering (IPO) date, (ii) June 30, 2005, or (iii) at the holder's option, immediately upon the occurrence of any Liquidity Event. The term "Liquidity Event" includes any of a decision of the Board of Directors of Progeon to make an IPO, merger, reconstruction, capital reorganization or other event which, in the sole opinion of the holder of the convertible preference shares, amounts to an alteration in the capital structure of Progeon. Each preference share was convertible into one equity share of par value $0.20 each. Indian law requires redemption of preference shares within a period of 20 years.

The carrying value of the preference shares was $21 million as of March 31, 2005. On June 30, 2005, the preference shares have been converted to equity shares of Progeon as per the terms of the stock subscription agreement. As of December 31, 2005, CIFC holds 8,750,000 equity shares of Progeon. Infosys' percentage ownership in Progeon immediately before and immediately after the conversion of preference shares was 99.5% and 73.4% respectively. The transaction resulted in a change of $12 million in the proportionate share of Infosys in the equity of Progeon and the change has been accounted for as an equity transaction in consolidation.

2.12 Other income, net

Other income, net, consists of the following:

(Dollars in millions)

Nine months ended December 31,

2004

2005

Interest income

$

12

$

17

Income from mutual fund investments

6

13

Foreign exchange loss, net

(1)

(15)

$

17

$

15

2.13 Research and development

Research and development expenses were $11 million and $17 million for the nine months ended December 31, 2004 and 2005.

2.14 Employees' Stock Offer Plans (ESOP)

In September 1994, the company established the 1994 plan, which provided for the issue of 24,000,000 warrants, as adjusted, to eligible employees. The warrants were issued to an employee welfare trust (the Trust). In 1997, in anticipation of a share dividend to be declared by the company, the Trust exercised all warrants held by it and converted them into equity shares. As and when the Trust issued options / stock to eligible employees, the difference between the market price and the exercise price was accounted as deferred stock compensation expense and amortized over the vesting period. The deferred stock compensation expense has been completely amortized as of March 31, 2004. The 1994 plan lapsed in fiscal 2000.

1998 Employees Stock Offer Plan (the 1998 Plan). The company's 1998 Plan provides for the grant of non-statutory stock options and incentive stock options to employees of the company. The establishment of the 1998 Plan was approved by the Board of Directors in December 1997 and by the stockholders in January 1998. The Government of India has approved the 1998 Plan, subject to a limit of 5,880,000 equity shares representing 5,880,000 ADS to be issued under the 1998 Plan. Unless terminated sooner, the 1998 Plan will terminate automatically in January 2008. All options under the 1998 Plan will be exercisable for equity shares represented by ADSs. The 1998 Plan is administered by a Compensation Committee comprising four members, all of who are independent directors on the Board of Directors.

1999 Stock Offer Plan (the 1999 Plan). In fiscal 2000, the company instituted the 1999 Plan. The stockholders and the Board of Directors approved the 1999 Plan in June 1999. The 1999 Plan provides for the issue of 26,400,000 equity shares to employees. The 1999 Plan is administered by a Compensation Committee comprising four members, all of who are independent directors on the Board of Directors. Under the 1999 Plan, options will be issued to employees at an exercise price, which shall not be less than the Fair Market Value (FMV). Under the 1999 Plan, options may also be issued to employees at exercise prices that are less than FMV only if specifically approved by the members of the company in a general meeting. All options under the 1999 plan are exercisable for equity shares.

The options under the 1998 Plan and 1999 Plan vest over a period of one through four years and expire 5 years from the date of completion of vesting.

The activity in the warrants / equity shares of the 1994, 1998 and 1999 ESOP during the nine months ended December 31, 2004 and 2005 are set out below.

Nine months ended December 31,

2004

2005

Shares
arising
out of options

Weighted
average
exercise
price

Shares
arising
out of options

Weighted
average
exercise
price

1994 Option plan:

Outstanding at the beginning of the period

1,266,400

-

-

-

Granted

-

-

-

-

Forfeited

-

-

-

-

Exercised

(1,266,400)

$

0.3

-

Outstanding at the end of the period

-

-

1998 Option plan:

Outstanding at the beginning of the period

3,871,008

3,054,290

Granted

-

-

Forfeited

(178,914)

$

44

(59,248)

$

41

Exercised

(371,647)

$

34

(547,378)

$

36

Outstanding at the end of the period

3,320,447

2,447,664

Exercisable at the end of the period

1,722,907

1,987,884

Weighted-average fair value of options granted during the period

-

-

1999 Option plan:

Outstanding at the beginning of the period

18,362,120

-

14,054,937

-

Granted

-

-

Forfeited

(780,217)

$

26

(147,106)

$

25

Exercised

(2,520,433)

$

21

(3,407,236)

$

24

Outstanding at the end of the period

15,061,470

10,500,595

Exercisable at the end of the period

9,257,022

9,189,634

Weighted-average fair value of options granted during the period

-

-

The following table summarizes information about stock options outstanding as of December 31, 2005.

Options Outstanding

Options Exercisable

Range of exercise prices per share ($)

No. of shares
arising out of options

Weighted average
remaining contractual life in years

Weighted
average
exercise price

No. of shares arising
out of options

Weighted
average
exercise price

1998 Plan

9-25

628,663

3.7

20

569,163

$

20

26-50

1,418,661

3.9

39

1,018,381

$

42

51-75

138,140

2.9

60

138,140

$

60

76-100

208,400

2.4

81

208,400

$

81

101-165

53,800

2.2

129

53,800

$

129

Total

2,447,664

1,987,884

1999 Plan

13-25

6,226,866 

3.7

19

5,026,846 

$

19

26-50

4,206,804 

2.9

35

4,095,863 

$

35 

51-70

66,925

2.2

53 

66,925

$

53 

Total

10,500,595

9,189,634

Progeon's 2002 Plan provides for the grant of stock options to its employees and was approved by its board of directors and stockholders in June 2002. All options under the 2002 Plan are exercisable for equity shares. The 2002 Plan is administered by a Compensation Committee comprising three members, all of whom are directors of Progeon. The 2002 Plan provides for the issue of 5,250,000 equity shares to employees, at an exercise price, which shall not be less than the FMV. Options may also be issued to employees at exercise prices that are less than FMV only if specifically approved by the members of Progeon in general meeting. The options issued under the 2002 Plan vest in periods ranging between one through six years, although accelerated vesting based on performance conditions is provided in certain instances. All options granted have been accounted for as a fixed plan.

Nine months ended December 31,

2004

2005

Shares
arising
out of options

Weighted
average
exercise price

Shares
arising
out of options

Weighted
average
exercise price

Progeon's 2002 Plan

Outstanding at the beginning of the period

3,124,625

3,116,518 

Granted

325,500

$

2.29

994,120

$

4.65

Forfeited

(270,500)

$

1.52

(376,979)

$

2.11

Exercised

(8,025 )

$

0.69

(640,975)

$

0.74

Outstanding at the end of the period

3,171,600

$

1.09

3,092,684

$

2.34

Exercisable at the end of the period

476,988

0.69

462,444

1.33

Weighted-average fair value of options granted during the period

0.81

1.87

The outstanding options of Progeon as of December 31, 2005 have a weighted average remaining contractual life of 1.7 years.

2.15 Income taxes

The provision for income taxes in the income statement comprises:

(Dollars in millions)

Nine months ended December 31,

Current taxes

2004

2005

Domestic taxes

$

12

$

17

Foreign taxes

43

37

55

54

Deferred taxes

Domestic taxes

(1)

(1)

Foreign taxes

(2)

(1)

(3)

(2)

Aggregate taxes

$

52

$

52

All components of the aggregate taxes of $52 million for the nine months ended December 31, 2004 and 2005 are allocated to the continuing operations of the company. Foreign current taxes for the nine months ended December 31, 2005 include a credit of $5 million being the effect of a change in the estimate of taxes payable in a foreign jurisdiction. The decrease in the estimate arose on completion of assessment proceedings by taxation authorities.

The tax effects of significant temporary differences that resulted in deferred tax assets and liabilities, and a description of the financial statement items that created these differences are as follows:

(Dollars in millions)

As of

Deferred tax assets:

March 31, 2005

December 31, 2005

Property, plant and equipment

$

8

$

11

Allowances on trade accounts receivable

1

-

Investments

1

1

Compensated absences and other accruals

1

1

Others

-

1

11

14

Less: Valuation allowance

(1)

(1)

10

13

Deferred tax liabilities:

Unrealized gain on investments in liquid mutual fund units

-

(1)

 Net deferred tax assets

$

10

$

12

The provision for foreign taxes is due to income taxes payable overseas, principally in the United States of America. The company benefits from certain significant tax incentives provided to software firms under Indian tax laws. These incentives presently include those for facilities set up under the Special Economic Zones Act, 2005 and an exemption from payment of Indian corporate income taxes for a period of ten consecutive years of operation of software development facilities designated as "Software Technology Parks" (the STP Tax Holiday). The Government of India has amended the tax incentives available to companies set up in designated STPs. The period of the STP Tax Holiday available to such companies is restricted to ten consecutive years, beginning from the financial year when the unit started producing computer software or April 1, 1999, whichever is earlier. The tax holidays on all facilities under STPs expire in stages by 2009.

Infosys is subject to a 15% Branch Profit Tax (BPT) in the U.S. to the extent its U.S. branch's net profit during the year is greater than the increase in the net assets of the U.S. branch during the fiscal year, computed in accordance with the Internal Revenue Code. At March 31, 2005, Infosys' US branch net assets amounted to approximately $187 million. As of March 31, 2005 and December 31, 2005, the company has not triggered the BPT and intends to maintain the current level of its net assets in the US, as it is consistent with its business plan. Accordingly, a BPT provision has not been recorded.

2.16 Earnings per share

The following is a reconciliation of the equity shares used in the computation of basic and diluted earnings per equity share:

Nine months ended December 31,

2004

2005

Basic earnings per equity share - weighted average number of common shares outstanding excluding unallocated shares of ESOP

266,307,767

270,875,779

Effect of dilutive common equivalent shares - stock options outstanding

6,274,194

7,558,602

Diluted earnings per equity share - weighted average number of common shares and common equivalent shares outstanding

272,581,961

278,434,381

Options to purchase 275,495 shares under the 1998 Plan and 90,213 shares under the 1999 Plan were not considered for calculating diluted earnings per share for the nine months ended December 31, 2005 as their effect was anti-dilutive.

2.17 Derivative financial instruments

The company uses derivative financial instruments such as foreign exchange forward and option contracts to mitigate the risk of changes in foreign exchange rates on accounts receivable and forecasted cash flows denominated in certain foreign currencies. The counterparty for these contracts is generally a bank. Infosys held foreign exchange forward contracts of $353 million and $15 million as of March 31, 2005 and December 31, 2005 respectively. The foreign exchange forward contracts mature between one to 12 months. As of December 31, 2005, the company held foreign currency option contracts of $26 million and range barrier options of $238 million, Euro 6 million and United Kingdom Pound Sterling 6 million.

2.18 Segment reporting

SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information, establishes standards for the way that public business enterprises report information about operating segments and related disclosures about products and services, geographic areas, and major customers. The company's operations predominantly relate to providing IT solutions, delivered to customers located globally, across various industry segments. The Chief Operating Decision Maker evaluates the company's performance and allocates resources based on an analysis of various performance indicators by industry classes and geographic segmentation of customers. Accordingly, revenues represented along industry classes comprise the principal basis of segmental information set out in these financial statements. Secondary segmental reporting is performed on the basis of the geographical location of customers. The accounting principles used in the preparation of the financial statements are consistently applied to record revenue and expenditure in individual segments, and are as set out in the summary of significant accounting policies.

Nine months ended December 31, 2004

Financial services

Manufacturing

Telecom

Retail

Others

Total

Revenues

$395

$167

$207

$114

$254

$1,137

Identifiable operating expenses

167

73

87

45

103

475

Allocated expenses

107

39

50

27

70

293

Segmental operating income

$121

$55

$70

$42

$81

$369

Unallocable expenses

42

Operating income

327

Other income, net

17

Income before income taxes

344

Provision for income taxes

52

Net income

$292

Nine months ended December 31, 2005

Financial services

Manufacturing

Telecom

Retail

Others

Total

Revenues

$561

$213

$257

$159

$369

$1,559

Identifiable operating expenses

236

94

97

65

148

640

Allocated expenses

147

54

61

43

106

411

Segmental operating income

$178

$65

$99

$51

$115

$508

Unallocable expenses

65

Operating income

443

Other income, net

15

Income before income taxes and minority interest

458

Provision for income taxes

52

Income before minority interest

406

Minority interest

3

Net income

$403

Nine months ended December 31, 2004

North America

Europe

India

Rest of the World

Total

Revenues

$746

$250

$21

$120

$1,137

Identifiable operating expenses

313

101

5

56

475

Allocated expenses

184

59

5

46

294

Segmental operating income

$249

$90

$11

$18

$368

Unallocable expenses

41

Operating income

327

Other income, net

17

Income before income taxes

344

Provision for income taxes

52

Net income

$292

Nine months ended December 31, 2005

North America

Europe

India

Rest of the
World

Total

Revenues

$1,009

$377

$27

$146

$1,559

Identifiable operating expenses

422

150

13

55

640

Allocated expenses

259

91

7

54

411

Segmental operating income

$328

$136

$7

$37

$508

Unallocable expenses

65

Operating income

443

Other income, net

15

Income before income taxes and minority interest

458

Provision for income taxes

52

Income before minority interest

406

Minority interest

3

Net income

$403

2.18.3 Significant clients

No client individually accounted for more than 10% of the revenues in the nine months ended December 31, 2004 and 2005.

2.19 Commitments and contingencies

The company has outstanding performance guarantees for various statutory purposes totaling $4 million and $7 million as of March 31, 2005 and December 31, 2005. These guarantees are generally provided to governmental agencies.

2.20 Litigation

The company is subject to legal proceedings and claims which have arisen in the ordinary course of its business. Legal actions, when ultimately concluded and determined, will not, in the opinion of management, have a material effect on the results of operations or the financial position of the company.

2.21 Tax contingencies

On April 15, 2005, the company received a demand from the Indian tax authorities for payment of additional tax of $11 million, including interest of $3 million, upon completion of their tax review for fiscal 2002. The tax demand is mainly on account of disallowance of a portion of the deduction to its taxable income under Indian law claimed by the company under Section 10A of the Income-tax Act. Deduction under Section 10A of the Income-tax Act is determined by the ratio of "Export Turnover" to "Total Turnover". The disallowance arose from certain expenses incurred in foreign currency being reduced from Export Turnover but not also reduced from Total Turnover.

The company is contesting the demand and management, including its tax advisers, believes that its position will likely be upheld in the appellate process. No tax expense has been accrued in the financial statements for the tax demand raised. Management believes that the ultimate outcome of this proceeding will not have a material adverse effect on the company's financial position and results of operations.

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Investors are cautioned that this discussion contains forward-looking statements that involve risks and uncertainties. When used in this discussion, the words "anticipate," "believe," "estimate," "expect," "intend," "project," "seek," "should," "will" and other similar expressions as they relate to us or our business are intended to identify such forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Actual results, performances or achievements could differ materially from those expressed or implied in such forward-looking statements. Factors that could cause or contribute to such differences include those described under the heading "Risk Factors" in this Report. Readers are cautioned not to place undue reliance on these forward-looking statements, as they speak only as of the date of this Report. The following discussion and analysis should be read in conjunction with our financial statements included herein and the notes thereto.

Overview

We are a leading global technology services company founded in 1981, and headquartered in Bangalore, India. We provide comprehensive end-to-end business solutions that leverage technology for our clients, including consulting, design, development, software re-engineering, maintenance, systems integration, package evaluation and implementation and infrastructure management services. We also provide software products to the banking industry. Through Progeon, we provide business process management services such as offsite customer relationship management, finance and accounting, and administration and sales order processing. Our clients rely on our solutions to enhance their business performance.

We completed our initial public offering of equity shares in India in 1993 and our initial public offering of ADSs in the United States in 1999. In August 2003 and June 2005, we completed sponsored secondary offerings of ADSs in the United States. We did not receive any of the proceeds from the 2003 and 2005 sponsored secondary offerings.

Our revenues grew from $414 million in fiscal 2001 to $1,592 million in fiscal 2005, representing a compound annual growth rate of 40.0%. Our net income grew from $132 million to $419 million during the same period, representing a compound annual growth rate of 33.5%. Our revenues for the nine months ended December 31, 2005 grew by 37.1% over the corresponding period in 2004 from $1,137 million to $1,559 million. Our net income for the nine months ended December 31, 2005 grew by 38.0% over the corresponding period in 2004 from $292 million to $403 million. Our revenue growth is attributable to a number of factors including an increase in the size and number of projects executed for existing and new clients, as well as an expansion in the solutions that we provide to our clients. For the nine months ended December 31, 2005, fiscal 2005 and fiscal 2004, 96.1%, 95.4% and 93.4% of our revenue came from repeat business, which we define as revenue from a client who also contributed to our revenue during the prior fiscal year. Between March 31, 2001 and March 31, 2005, our total number of employees grew from approximately 9,800 to approximately 36,800 representing a compound annual growth rate of 39.2%. As of December 31, 2005, we had approximately 49,400 employees.

We use a distributed project management methodology that we refer to as our Global Delivery Model. We divide projects into components that we execute simultaneously at client sites and at our geographically dispersed development centers in India and around the world. Our Global Delivery Model allows us to efficiently execute projects across time zones and development centers, thereby optimizing our cost structure. We also offer a secure and redundant infrastructure for all client data. During fiscal 2005, we earned 65.2% of our total revenues from North America, 22.3% from Europe, 1.9% from India and 10.6% from the rest of the world. During the nine months ended December 31, 2005, we earned 64.7% of our total revenues from North America, 24.2% from Europe, 1.7% from India and 9.4% from the rest of the world.

Revenues

Our revenues are generated principally from technology services provided on either a time-and-materials or a fixed-price, fixed-timeframe basis. Revenues from services provided on a time-and-materials basis are recognized as the related services are performed. Revenues from services provided on a fixed-price, fixed-timeframe basis are recognized pursuant to the percentage of completion method. Most of our client contracts including those that are on a fixed-price, fixed-timeframe basis can be terminated by clients with or without cause, without penalties and with short notice periods ranging from zero to 90 days. Since we collect revenues on contracts as portions of the contracts are completed, terminated contracts are only subject to collection for portions of the contract completed through the time of termination. Our contracts generally do not contain specific termination-related penalty provisions. In order to manage and anticipate the risk of early or abrupt con tract terminations, we monitor the progress on all contracts and change orders according to their characteristics and the circumstances in which they occur. This includes a focused review of our ability and our client's ability to perform on the contract, a review of extraordinary conditions that may lead to a contract termination, as well as historical client performance considerations. Since we also bear the risk of cost overruns and inflation with respect to fixed-price, fixed-timeframe projects, our operating results could be adversely affected by inaccurate estimates of contract completion costs and dates, including wage inflation rates and currency exchange rates that may affect cost projections. Losses on contracts, if any, are provided for in full in the period when determined. Although we revise our project completion estimates from time to time, such revisions have not, to date, had a material adverse effect on our operating results or financial condition. Currency fluctuations, particularly when t he rupee appreciates or depreciates in value against the currency in which billings are to be performed under a contract, can also affect reported revenues. We also generate revenue from software application products, including banking software. Such software products represented 4.0% and 3.0% of our total revenues for the nine months ended December 31, 2005 and fiscal 2005.

We experience from time to time pricing pressure from our clients, especially during economic downturns, which had adversely affected our revenues, margins and gross profits. For example, clients often expect that as we do more business with them, they will receive volume discounts. Additionally, clients may ask for fixed-price arrangements or reduced rates. We attempt to use fixed-price arrangements for work where the specifications are complete, so individual rates are not negotiated. We are also adding new services at higher price points and where more value is added for our clients. More recently, some of our clients have delayed purchase decisions as they seek to comply, as applicable, with increased regulations, such as the Sarbanes-Oxley Act of 2002, or undergo corporate reorganizations.

Cost of Revenues

Our cost of revenues primarily consists of salary and other compensation expenses, depreciation, overseas travel expenses, cost of software purchased for internal use, cost of technical subcontractors, data communications expenses and computer maintenance. We depreciate our personal computers and servers over two years and mainframe computers over periods of up to three years. Third party software is amortized over the estimated useful life.

We typically assume full project management responsibility for each project that we undertake. Approximately 72.3% and 71.3% of the total billed person-months for our services during the nine months ended December 31, 2005 and fiscal 2005 were performed at our global development centers in India, and the balance of the work was performed at client sites and global development centers located outside India. The proportion of work performed at our facilities and at client sites varies from quarter to quarter. We charge higher rates and incur higher compensation and other expenses for work performed at client sites and global development centers located outside India. Services performed at a client site or global development centers located outside India typically generate higher revenues per-capita at a lower gross margin than the same services performed at our facilities in India. As a result, our total revenues, cost of revenues and gross profit in absolute terms and as a percentage of revenues fluctuate from quarter to quarter based on the proportion of work performed outside India. Additionally, any increase in work performed at client sites or global development centers located outside India can increase our costs, including visas charges and other costs incurred in anticipation of such work, and decrease our gross profits. We hire subcontractors on a limited basis from time to time for our own technology development needs, and we generally do not perform subcontracted work for other technology service providers. For the nine months ended December 31, 2005 and fiscal 2005, approximately 2.8% and 2.7% of our cost of revenues was attributable to cost of technical subcontractors. We do not anticipate that our subcontracting needs will increase significantly as we expand our business. Revenues and gross profits are also affected by employee utilization rates. We define employee utilization as the proportion of total billed person months to total available person months excluding support personnel. We manage utilization by monitoring project requirements and timetables. The number of consultants assigned to a project will vary according to size, complexity, duration, and demands of the project. An unanticipated termination of a significant project could also cause us to experience lower utilization of technology professionals, resulting in a higher than expected number of unassigned technology professionals. In addition, we do not fully utilize our technology professionals when they are enrolled in training programs, particularly during our 14-week training course for new employees.

Selling and Marketing Expenses

Selling and marketing expenses represented 6.5% of total revenues for the nine months ended December 31, 2005 and fiscal 2005. Our selling and marketing expenses primarily consist of expenses relating to salaries of sales and marketing personnel, travel, brand building, rental for sales and marketing offices and telecommunications. We have decided to increase our selling and marketing expenses to increase brand awareness among target clients and promote client loyalty and repeat business among existing clients.

General and Administrative Expenses

General and administrative expenses represented 8.0% of total revenues for the nine months ended December 31, 2005 and fiscal 2005. Our general and administrative expenses are comprised of expenses relating to salaries of senior management and other support personnel, travel expenses, legal and other professional fees, telecommunications, utilities, other miscellaneous administrative costs and provisions for doubtful accounts receivable. The factors which affect the fluctuations in our provisions for bad debts and write offs of uncollectible accounts include the financial health of our clients and of the economic environment in which they operate.

Amortization of Intangible Assets

Our amortization of intangible assets relate to identified intangibles arising from purchase price allocations for business combinations. We amortize intangible assets over their estimated useful lives.

Other Income, net

Other income, net includes interest income, income from liquid mutual fund investments and foreign currency exchange gains/losses including marked to market gain/losses on foreign exchange forward and option contracts.

Functional Currency and Foreign Exchange

Our functional currency is the Indian rupee. The functional currency for Infosys Australia, Infosys China and Infosys Consulting is the respective local currency. The financial statements included in this Report are reported in U.S. dollars The translation of rupees to dollars is performed for the balance sheet accounts using the exchange rate in effect at the balance sheet date, and for revenue and expense accounts using a monthly average exchange rate for the respective periods. The gains or losses resulting from such translation are reported as other comprehensive income.

Generally, Indian law requires residents of India to repatriate any foreign currency earnings to India to control the exchange of foreign currency. More specifically, Section 8 of the Foreign Exchange Management Act, or FEMA, requires an Indian company to take all reasonable steps to realize and repatriate into India all foreign exchange earned by the company outside India, within such time periods and in the manner as specified by the Reserve Bank of India, or RBI. The RBI has promulgated guidelines that require the company to repatriate any realized foreign exchange back to India, and either:

• sell it to an authorized dealer for rupees within seven days from the date of receipt of the foreign exchange;
• retain it in a foreign currency account such as an Exchange Earners Foreign Currency, or EEFC, account with an authorized dealer; or
• use it for discharge of debt or liabilities denominated in foreign exchange

We typically collect our earnings and pay expenses denominated in foreign currencies using a dedicated foreign currency account located in the local country of operation. In order to do this, we are required to, and have obtained, special approval from the RBI to maintain a foreign currency account in overseas countries like the United States. However, the RBI approval is subject to limitations, including a requirement that we repatriate all foreign currency in the account back to India within a reasonable time, except an amount equal to our local monthly operational cost of our overseas branch and personnel. We currently pay such expenses and repatriate the remainder of the foreign currency to India on a regular basis. We have the option to retain those in an EEFC account (foreign currency denominated) or an Indian-rupee-denominated account. We convert substantially all of our foreign currency to rupees to fund operations and expansion activities in India.

Our failure to comply with these regulations could result in RBI enforcement actions against us.

Income Taxes

Our net income earned from providing software development and other services outside India is subject to tax in the country where we perform the work. Most of our tax paid in countries other than India can be applied as a credit against our Indian tax liability to the extent that the same income is subject to tax in India.

Currently, we benefit from the tax holidays the Government of India gives to the export of software from specially designated software technology parks in India and for facilities set up under the Special Economic Zones Act, 2005. As a result of these incentives, our operations have been subject to relatively low tax liabilities. These tax incentives include a 10-year tax holiday from Indian corporate income taxes for the operation of most of our Indian facilities. As a result of these tax exemptions, a substantial portion of our pre-tax income has not been subject to significant tax in recent years. These tax incentives resulted in a decrease in our income tax expense of $115 million and $126 million for the nine months ended December 31, 2005 and fiscal 2005 compared to the effective tax amounts that we estimate would have applied if these incentives had not been available.

The Finance Act, 2000 phases out the ten-year tax holiday related to the specially designated software technology parks over a ten-year period from fiscal 2000 through fiscal 2009. Accordingly, facilities set up in India on or before March 31, 2000 have a ten-year tax holiday, new facilities set up on or before March 31, 2001 have a nine-year tax holiday and so forth until March 31, 2009. After March 31, 2009, the tax holiday will no longer be available to new facilities. Our current tax holidays for specially designated software technology parks expire in stages by 2009. Some of our new facilities are being set up under the Special Economic Zones Act, 2005. When our tax holidays expire or terminate, our tax expense will materially increase, reducing our profitability. As a result of such tax incentives, our effective tax rate for fiscal 2005 was 14.7% and our Indian statutory tax rate for the same period was 36.6%. Our effective tax rate for the nine months ended December 31, 2005 was 11.4% and our Indian statutory tax rate fo r the same period was 33.7%.

Results for the three months ended December 31, 2005 compared to the three months ended December 31, 2004

Revenues

Our revenues were $559 million in the three months ended December 31, 2005, representing an increase of $136 million, or 32.2%, over revenues of $423 million for the three months ended December 31, 2004. Revenues increased in most segments of our services. The increase in revenues was attributable to an increase in business from both existing clients and from new clients, particularly in industries such as financial services, retail, manufacturing, utilities and services. Our clients in the financial services industry comprised 35.9% and 35.2% of revenues for the three months ended December 31, 2005 and 2004. Clients in the manufacturing sector comprised 14.1% and 14.3% of revenues for the same periods. Our clients in the retail industry comprised 10.3% and 9.4% of revenues for the three months ended December 31, 2005 and 2004, while our clients in the telecommunications industry comprised 15.8% and 18.1% of revenues for the same periods. Clients in other industries such as utilities, logistics and services, contributed 23.9% and 23.0% of revenues for the three months ended December 31, 2005 and 2004. Revenues from services represented 96.2% of total revenues for the three months ended December 31, 2005 as compared to 97.0% for the three months ended December 31, 2004. Revenues from fixed-price, fixed-timeframe contracts and from time-and-materials contracts represented 28.4 % and 71.6 % of total services revenues for the three months ended December 31, 2005, as compared to 31.4 % and 68.6 % for the three months ended December 31, 2004. Sales of our software products represented 3.8% of our total revenues for the three months ended December 31, 2005 as compared to 3.0% for the three months ended December 31, 2004. Revenues from North America, Europe, India and the rest of the world represented 65.0%, 24.9%, 1.4% and 8.7% of total revenues for three months ended December 31, 2005 as compared to 66.6%, 22.1%, 2.1% and 9.2% for the three months ended December 31, 2004.

Currency fluctuations when the rupee appreciates or depreciates in value against the currency in which billings are to be performed under a contract have an effect on reported revenues. For the three months ended December 31, 2005 and 2004, U.S. dollar denominated revenues represented 79.1% and 77.3% of total revenues. For the same periods, revenues denominated in United Kingdom Pound Sterling represented 8.8% and 6.9% of total revenues, while revenues denominated in the Euro represented 4.8% and 5.2% of total revenues. The average exchange rate between the rupee and the United Kingdom Pound Sterling was Rs.78.82 per United Kingdom Pound Sterling in the three months ended December 31, 2005 compared to Rs.83.85 in the three months ended December 31, 2004 resulting in an average appreciation of 6.0% in the value of the rupee against the United Kingdom Pound Sterling. The average exchange rate between the rupee and the Euro was Rs.53.80 per Euro in the three months ended December 31, 2005 compared to Rs.58.79 in the three months ended December 31, 2004 resulting in an average appreciation of 8.5% in the value of the rupee against the Euro.

During the three months ended December 31, 2005 the total billed person-months for our services other than business process management grew by 27.5% compared to the three months ended December 31, 2004. The onsite and offshore volume growth were 30.1% and 26.4% during the three months ended December 31, 2005 compared to the three months ended December 31, 2004. We have recently seen a slight increase in pricing on engagements with some of our customers. During the three months ended December 31, 2005 there was 0.5% increase in onsite rates and a 1.0% increase in offshore rates compared to the three months ended December 31, 2004.

Cost of revenues

Our cost of revenues was $319 million for the three months ended December 31, 2005, representing an increase of $78 million, or 32.4%, over our cost of revenues of $241 million for the three months ended December 31, 2004. Cost of revenues represented 57.1% and 57.0% of total revenues for the three months ended December 31, 2005 and 2004. The increase in our cost of revenues is mainly attributable to increases of approximately $61 million in personnel costs due to new hires and a compensation review effected in April 2005, $9 million in depreciation expenses, $5 million in overseas travel expenses including visa costs and $1 million each in rental expenses, travel expenses and cost of technical subcontractors. There has been a decrease of $1 million in accruals for post sales customer support.

Gross profit

Our gross profit was $240 million for the three months ended December 31, 2005, representing an increase of $58 million, or 31.9%, over our gross profit of $182 million for the three months ended December 31, 2004. As a percentage of revenues, gross profit decreased to 42.9% for the three months ended December 31, 2005 from 43.0% for the three months ended December 31, 2004. The decrease is attributable to a 32.2% increase in revenues for the three months ended December 31, 2005 offset by a 32.4% increase in cost of revenues in the same period compared to the three months ended December 31, 2004.

Selling and marketing expenses

We incurred selling and marketing expenses of $35 million in the three months ended December 31, 2005 representing an increase of $9 million, or 34.6%, over the $26 million expended in the three months ended December 31, 2004. The number of our sales and marketing personnel increased to 412 as of December 31, 2005, from 328 as of December 31, 2004. The increase in selling and marketing expenses is mainly attributable to increases of approximately $6 million in personnel costs of selling and marketing employees on account of new hires and the compensation review and $1 million each in brand building expenses and overseas travel expenses. Selling and marketing expenses were 6.3% and 6.1% of total revenue, for the three months ended December 31, 2005 and 2004.

General and administrative expenses

Our general and administrative expenses were $41 million for the three months ended December 31, 2005, representing an increase of $7 million, or 20.6%, over general and administrative expenses of $34 million for the three months ended December 31, 2004. General and administrative expenses were 7.3% and 8.0% of total revenues for the three months ended December 31, 2005 and 2004. The increase in general and administrative expenses was primarily attributable to increases of approximately $1 million in personnel costs on account of new hires and the compensation review, $2 million each in travel expenses, office maintenance expenses and telecommunication expenses and $1 million each in professional charges and power and fuel charges. There has been a decrease of $2 million in the provision for bad and doubtful debts. The factors which affect the fluctuations in our provisions for bad debts and write offs of uncollectible accounts include the financial health and economic environment of our clients. We specifically identify the credit loss and then make the provision. No one client has contributed significantly to a loss, and we have had no significant changes in our collection policies or payment terms.

Operating income

Our operating income was $164 million for the three months ended December 31, 2005 representing an increase of $42 million, or 34.4%, over our operating income of $122 million for the three months ended December 31, 2004. As a percentage of revenues, operating income increased to 29.3% for the three months ended December 31, 2005 from 28.8% for the three months ended December 31, 2004.

Other income, net

Other income,net, consisting mainly of interest and dividend income and foreign exchange gains/(losses), net, was $1 million loss for the three months ended December 31, 2005. Other income was $11 million for the three months ended December 31, 2004. Interest and dividend income was approximately $11 million and $6 million during the three months ended December 31, 2005 and 2004. We had a foreign currency exchange loss of $13 million for the three months ended December 31, 2005 compared to gains of $5 million in the three months ended December 31, 2004.

For the three months ended December 31, 2005 and 2004, U.S. dollar denominated revenues represented 79.1% and 77.3% of total revenues. For the same periods, revenues denominated in United Kingdom Pound Sterling represented 8.8% and 6.9% of total revenues while revenues denominated in the Euro represented 4.8% and 5.2% of total revenues.

The average exchange rate between the rupee and the U.S. dollar was Rs.45.30 per U.S. dollar in the three months ended December 31, 2005 compared to Rs.44.35 in the three months ended December 31, 2004 resulting in an average depreciation of 2.1% in the value of the rupee against the U.S. dollar. The closing exchange rate between the rupee and the U.S. dollar was Rs.44.95 per U.S. dollar on December 31, 2005 compared to Rs.43.94 as of September 30, 2005 resulting in a depreciation of 2.3% in the value of the rupee against the U.S. dollar. The closing exchange rate between the rupee and the U.S. dollar was Rs.43.27 per U.S. dollar on December 31, 2004 compared to Rs.45.91 as of September 30, 2004 resulting in an appreciation of 5.8% in the value of the rupee against the U.S. dollar.

The average exchange rate between the rupee and the United Kingdom Pound Sterling was Rs.78.82 per United Kingdom Pound Sterling in the three months ended December 31, 2005 compared to Rs.83.85 in the three months ended December 31, 2004 resulting in an average appreciation of 6.0% in the value of the rupee against the United Kingdom Pound Sterling. The closing exchange rate between the rupee and the United Kingdom Pound Sterling was Rs.77.26 per United Kingdom Pound Sterling on December 31, 2005 compared to Rs.77.76 as of September 30, 2005 resulting in an appreciation of 0.6% in the value of the rupee against the United Kingdom Pound Sterling. The closing exchange rate between the rupee and the United Kingdom Pound Sterling was Rs.83.93 per United Kingdom Pound Sterling on December 31, 2004 compared to Rs.83.60 as of September 30, 2004 resulting in a depreciation of 0.4% in the value of the rupee against the United Kingdom Pound Sterling.

The average exchange rate between the rupee and the Euro was Rs.53.80 per Euro in the three months ended December 31, 2005 compared to Rs.58.79 in the three months ended December 31, 2004 resulting in an average appreciation of 8.5% in the value of the rupee against the Euro. The closing exchange rate between the rupee and the Euro was Rs.53.23 per Euro on December 31, 2005 compared to Rs.52.98 as of September 30, 2005 resulting in a depreciation of 0.5% in the value of the rupee against the Euro. The closing exchange rate between the rupee and the Euro was Rs.59.34 per Euro on December 31, 2004 compared to Rs.56.86 as of September 30, 2004 resulting in a depreciation of 4.4% in the value of the rupee against the Euro.

We use derivative financial instruments such as foreign exchange forward and option contracts to mitigate the risk of changes in foreign exchange rates on accounts receivable and forecasted cash flows denominated in certain foreign currencies. We held foreign exchange forward contracts of $353 million and $15 million as of March 31, 2005 and December 31, 2005 respectively. As of December 31, 2005, we held foreign currency option contracts of $26 million and range barrier options of $238 million, Euro 6 million and United Kingdom Pound Sterling 6 million. We have recorded a losses of $16 million on account of the foreign exchange forward and option contracts for the three months ended December 31, 2005 while we had recorded gains of $14 million for the three months ended December 31, 2004, which are included in total foreign currency exchange gains/losses. Our accounting policy requires us to mark to market and recognize the effect in earnings immediately of any derivative that is either not designated a hedge, or is so designated but is ineffective as per SFAS 133.

Provision for income taxes

Our provision for income taxes was $18 million for the three months ended December 31, 2005 representing a decrease of $3 million, or 14.3% compared to our provision for income taxes of $21 million for the three months ended December 31, 2004. Our effective tax rate decreased to 11.0% for the three months ended December 31, 2005 from 15.8% for the three months ended December 31, 2004 mainly due to decrease in other income,net. Other income,net, consisting mainly of interest and dividend income and foreign exchange gains/(losses), net, was $1 million loss for the three months ended December 31, 2005. Other income was $11 million for the three months ended December 31, 2004.

Minority interest

Minority interest of $2 million for the three months ended December 31, 2005 represents the share of minority shareholders in the profits of Progeon Limited, our majority owned and consolidated subsidiary.

Net income

Our net income was $143 million for the three months ended December 31, 2005 representing an increase of $31 million, or 27.7%, over our net income of $112 million for the three months ended December 31, 2004. As a percentage of total revenues, net income decreased to 25.6% for the three months ended December 31, 2005 from 26.5% for the three months ended December 31, 2004.

Results for the nine months ended December 31, 2005 compared to the nine months ended December 31, 2004

Revenues. Our revenues were $1,559 million in the nine months ended December 31, 2005, representing an increase of $422 million, or 37.1%, over revenues of $1,137 million for the nine months ended December 31, 2004. Revenues increased in most segments of our services. The increase in revenues was attributable to an increase in business from both existing clients and from new clients, particularly in industries such as financial services, manufacturing, retail, telecommunications, utilities and services. Our clients in the financial services industry comprised 36.0% and 34.7% of revenues for the nine months ended December 31, 2005 and 2004. Clients in the manufacturing sector comprised 13.7% and 14.7% of revenues for the same periods. Our clients in the retail industry comprised 10.2% and 10.0% of revenues for the nine months ended December 31, 2005 and 2004, while our clients in the telecommunications industry comprised 16.5% and 18.2% of revenues for the sa me periods. Clients in other industries such as utilities, logistics and services, contributed 23.6% and 22.4% of revenues for the nine months ended December 31, 2005 and 2004. Revenues from services represented 96.0% of total revenues for the nine months ended December 31, 2005 as compared to 97.2% for the nine months ended December 31, 2004. Revenues from fixed-price, fixed-timeframe contracts and from time-and-materials contracts represented 28.6% and 71.4% of total services revenues for the nine months ended December 31, 2005, as compared to 30.3% and 69.7% for the nine months ended December 31, 2004. Sales of our software products represented 4.0% of our total revenues for the nine months ended December 31, 2005 as compared to 2.8% for the nine months ended December 31, 2004. Revenues from North America, Europe, India and the rest of the world represented 64.7%, 24.2%, 1.7% and 9.4% of total revenues for nine months ended December 31, 2005 as compared to 65.6%, 22.0%, 1.8% and 10.6% for the nine months ended December 31, 2004.

Currency fluctuations when the rupee appreciates or depreciates in value against the currency in which billings are to be performed under a contract have an effect on reported revenues. For the nine months ended December 31, 2005 and 2004, U.S. dollar denominated revenues represented 78.8% and 78.3% of total revenues. For the same periods, revenues denominated in United Kingdom Pound Sterling represented 8.1% and 6.5% of total revenues, while revenues denominated in the Euro represented 4.5% and 4.9% of total revenues. The average exchange rate between the rupee and the United Kingdom Pound Sterling was Rs. 78.93 per United Kingdom Pound Sterling in the nine months ended December 31, 2005 compared to Rs. 83.24 in the nine months ended December 31, 2004 resulting in an average appreciation of 5.2% in the value of the rupee against the United Kingdom Pound Sterling. The average exchange rate between the rupee and the Euro was Rs. 53.83 per Euro in the nine months ended December 31, 2005 compared to Rs. 56.64 in the nine months ended December 31, 2004 resulting in an average appreciation of 5.0% in the value of the rupee against the Euro.

During the nine months ended December 31, 2005 the total billed person-months for our services other than business process management grew by 32.7% compared to the nine months ended December 31, 2004. The onsite and offshore volume growth were 31.7% and 33.2% during the nine months ended December 31, 2005 compared to the nine months ended December 31, 2004. We have recently seen a slight increase in pricing on engagements with some of our customers. During the nine months ended December 31, 2005 there was 0.5% increase in onsite rates and a 1.0% increase in offshore rates compared to the nine months ended December 31, 2004.

Cost of revenues. Our cost of revenues was $890 million for the nine months ended December 31, 2005, representing an increase of $248 million, or 38.6%, over our cost of revenues of $642 million for the nine months ended December 31, 2004. Cost of revenues represented 57.1% and 56.5% of total revenues for the nine months ended December 31, 2005 and 2004. The increase in our cost of revenues is mainly attributable to increases of approximately $187 million in personnel costs due to new hires and a compensation review effected in April 2005, $25 million in depreciation expenses, $9 million in cost of technical subcontractors, $17 million in overseas travel expenses including visa costs, $5 million in amortization of software purchased for our own use, and $2 million each in rental expenses and telecommunication charges. There has been a decrease of $6 million in accruals for post sales customer support.

Gross profit. As a result, our gross profit was $669 million for the nine months ended December 31, 2005, representing an increase of $174 million, or 35.2%, over our gross profit of $495 million for the nine months ended December 31, 2004. As a percentage of revenues, gross profit decreased to 42.9% for the nine months ended December 31, 2005 from 43.5% for the nine months ended December 31, 2004. The decrease is attributable to a 37.1% increase in revenues for the nine months ended December 31, 2005 offset by a 38.6% increase in cost of revenues in the same period compared to the nine months ended December 31, 2004.

Selling and marketing expenses. We incurred selling and marketing expenses of $102 million in the nine months ended December 31, 2005 representing an increase of $26 million, or 34.2%, over the $76 million expended in the nine months ended December 31, 2004. The number of our sales and marketing personnel increased to 412 as of December 31, 2005, from 328 as of December 31, 2004. The increase in selling and marketing expenses is mainly attributable to increases of approximately $16 million in personnel costs of selling and marketing employees on account of new hires and the compensation review, $3 million in overseas travel expenses $2 million each in brand building expenses and incentive commissions and $1 million each in rental expenses and professional charges. Selling and marketing expenses were 6.5% and 6.7% of total revenue, for the nine months ended December 31, 2005 and 2004.

General and administrative expenses. Our general and administrative expenses were $124 million for the nine months ended December 31, 2005, representing an increase of $33 million, or 36.3%, over general and administrative expenses of $91 million for the nine months ended December 31, 2004. General and administrative expenses were 8.0% of total revenues for the nine months ended December 31, 2005 and 2004. The increase in general and administrative expenses was primarily attributable to increases of approximately $8 million for personnel costs on account of new hires and the compensation review, $6 million in telecommunication charges, $5 million each in travel expenses, professional charges and office maintenance, $4 million in power and fuel charges and $2 million in overseas travel expenses. There has been a decrease of $3 million in the provision for bad and doubtful debts. The factors which affect the fluctuations in our provisions for bad debts and write offs of uncollectible accounts include the financial health and economic environment of our clients. We specifically identify the credit loss and then make the provision. No one client has contributed significantly to a loss, and we have had no significant changes in our collection policies or payment terms.

Amortization of intangible assets. There was no amortization of intangible assets for the nine months ended December 31, 2005. Amortization of intangible assets was $1 million for the nine months ended December 31, 2004. This relates to the identified customer contract intangibles arising on the allocation of purchase price of Infosys Australia.

Operating income. Our operating income was $443 million for the nine months ended December 31, 2005 representing an increase of $116 million, or 35.5%, over our operating income of $327 million for the nine months ended December 31, 2004. As a percentage of revenues, operating income decreased to 28.4% for the nine months ended December 31, 2005 from 28.7% for the nine months ended December 31, 2004.

Other income, net. Other income, consisting mainly of interest and dividend income and foreign exchange gains/(losses), net, was $15 million for the nine months ended December 31, 2005. Other income was $17 million for the nine months ended December 31, 2004. Interest and dividend income was approximately $30 million and $18 million during the nine months ended December 31, 2005 and 2004. We had foreign currency exchange loss of $15 million in the nine months ended December 31, 2005 compared to $1 million loss in the nine months ended December 31, 2004.

For the nine months ended December 31, 2005 and 2004, U.S. dollar denominated revenues represented 78.8% and 78.3% of total revenues. For the same periods, revenues denominated in United Kingdom Pound Sterling represented 8.1% and 6.5% of total revenues while revenues denominated in the Euro represented 4.5% and 4.9% of total revenues. The average exchange rate between the rupee and the U.S. dollar was Rs. 44.21 per U.S. dollar in the nine months ended December 31, 2005 compared to Rs. 45.29 in the nine months ended December 31, 2004 resulting in an average appreciation of 2.4% in the value of the rupee against the U.S. dollar. The closing exchange rate between the rupee and the U.S. dollar was Rs. 44.95 per U.S. dollar on December 31, 2005 compared to Rs. 43.62 as of March 31, 2005 resulting in a depreciation of 3.0% in the value of the rupee against the U.S. dollar. The closing exchange rate between the rupee and the U.S. dollar was Rs. 43.27 per U.S. dollar on Dec ember 31, 2004 compared to Rs. 43.40 as of March 31, 2004 resulting in an appreciation of 0.3% in the value of the rupee against the U.S. dollar.

The average exchange rate between the rupee and the United Kingdom Pound Sterling was Rs. 78.93 per United Kingdom Pound Sterling in the nine months ended December 31, 2005 compared to Rs. 83.24 in the nine months ended December 31, 2004 resulting in an average appreciation of 5.2% in the value of the rupee against the United Kingdom Pound Sterling. The closing exchange rate between the rupee and the United Kingdom Pound Sterling was Rs. 77.26 per United Kingdom Pound Sterling on December 31, 2005 compared to Rs. 82.18 as of March 31, 2005 resulting in an appreciation of 6.0% in the value of the rupee against the United Kingdom Pound Sterling. The closing exchange rate between the rupee and the United Kingdom Pound Sterling was Rs. 83.93 per United Kingdom Pound Sterling on December 31, 2004 compared to Rs. 80.52 as of March 31, 2004 resulting in a depreciation of 4.2% in the value of the rupee against the United Kingdom Pound Sterling.

The average exchange rate between the rupee and the Euro was Rs. 53.83 per Euro in the nine months ended December 31, 2005 compared to Rs.56.64 in the nine months ended December 31, 2004 resulting in an average appreciation of 5.0% in the value of the rupee against the Euro. The closing exchange rate between the rupee and the Euro was Rs. 53.23 per Euro on December 31, 2005 compared to Rs. 56.52 as of March 31, 2005 resulting in an appreciation of 5.8% in the value of the rupee against the Euro. The closing exchange rate between the rupee and the Euro was Rs. 59.34 per Euro on December 31, 2004 compared to Rs. 53.77 as of March 31, 2004 resulting in a depreciation of 10.4% in the value of the rupee against the Euro.

We use derivative financial instruments such as foreign exchange forward and option contracts to mitigate the risk of changes in foreign exchange rates on accounts receivable and forecasted cash flows denominated in certain foreign currencies. We held foreign exchange forward contracts of $353 million and $15 million as of March 31, 2005 and December 31, 2005 respectively. As of December 31, 2005, we held foreign currency option contracts of $26 million and range barrier options of $238 million, Euro 6 million and United Kingdom Pound Sterling 6 million. We have recorded losses of $16 million on account of the foreign exchange forward and option contracts for the nine months ended December 31, 2005 while we had recorded gains of less than $1 million for the nine months ended December 31, 2004, which are included in total foreign currency exchange gains/losses. Our accounting policy requires us to mark to market and recognize the effect in earnings immediately of any de rivative that is either not designated a hedge, or is so designated but is ineffective as per SFAS 133.

Provision for income taxes. Our provision for income taxes was $52 million for the nine months ended December 31, 2005 and December 31, 2004. Our effective tax rate decreased to 11.4% for the nine months ended December 31, 2005 from 15.1% for the nine months ended December 31, 2004 mainly due to decrease in other income,net and a credit of $5 million during the nine months ended December 31, 2005 being the effect of a change in the estimate of taxes payable in a foreign jurisdiction. The decrease in the estimate arose on completion of assessment proceedings by taxation authorities. Other income, consisting mainly of interest and dividend income and foreign exchange gains/(losses), net, was $15 million for the nine months ended December 31, 2005. Other income was $17 million for the nine months ended December 31, 2004.

Minority interest. Minority interest of $3 million for the nine months ended December 31, 2005 represents the share of minority shareholders in the profits of Progeon Limited, our majority owned and consolidated subsidiary.

Net income. Our net income was $403 million for the nine months ended December 31, 2005 representing an increase of $111 million, or 38.0%, over our net income of $292 million for the nine months ended December 31, 2004. As a percentage of total revenues, net income increased to 25.8% for the nine months ended December 31, 2005 from 25.7% for the nine months ended December 31, 2004.

Liquidity and Capital Resources

Our growth has been financed largely by cash generated from operations and, to a lesser extent, from the proceeds from the sale of equity. In 1993, we raised approximately $4.4 million in gross aggregate proceeds from our initial public offering of equity shares in India. In 1994, we raised an additional $7.7 million through private placements of our equity shares with foreign institutional investors, mutual funds, Indian domestic financial institutions and corporations. On March 11, 1999, we raised $70.4 million in gross aggregate proceeds from our initial public offering of ADSs in the United States.

As of December 31, 2005, we had $1,150 million in working capital, including $477 million in cash and cash equivalents and $492 million invested in liquid mutual fund units, and no outstanding bank borrowings. We believe that a sustained reduction in IT spending, a longer sales cycle, and a continued economic downturn in any of the various industry segments in which we operate, could result in a decline in our revenue and negatively impact our liquidity and cash resources.

Net cash provided by operating activities was $486 million and $268 million for the nine months ended December 31, 2005 and 2004. Net cash provided by operations consisted primarily of net income adjusted for depreciation and increases in unearned revenue, income taxes payable and decrease in accounts receivable offset in part by an increase in prepaid expenses and other current assets, unbilled revenue, accounts receivable and decrease in other accrued liabilities, income taxes payable and client deposits.

Trade accounts receivable increased by $16 million during the nine months ended December 31, 2005 compared to an increase of $85 million during the nine months ended December 31, 2004. Accounts receivable as a percentage of last 12 months revenues represented 15.4% and 16.7% as of December 31, 2005 and 2004. Other accrued liabilities increased by $20 million and $13 million during the nine months ended December 31, 2005 and 2004. Prepaid expenses and other current assets increased by $2 million and $1 million during the nine months ended December 31, 2005 and 2004. There has been an increase in unbilled revenues of $4 million during the nine months ended December 31, 2005 compared to an increase of $5 million during the nine months ended December 31, 2004. Unbilled revenues represent revenues that are recognized but not yet invoiced. Client deposits decreased by $4 million and $7 million during the nine months ended December 31, 2005 and 2004. Unearned revenues increased by $23 million and $11 million during the nine months ended December 31, 2005 and 2004. Unearned revenue resulted primarily from advance client billings on fixed-price, fixed-timeframe contracts for which related efforts have not been expended. Revenues from fixed-price, fixed-timeframe contracts and from time-and-materials contracts represented 28.6% and 71.4% of total services revenues for the nine months ended December 31, 2005, as compared to 30.3% and 69.7% for the nine months ended December 31, 2004. Income taxes payable has decreased by $3 million during the nine months ended December 31, 2005 while there was an increase of $11 million during the nine months ended December 31, 2004.

Net cash used in investing activities was $418 million and $164 million in the nine months ended December 31, 2005 and 2004. Net cash used in investing activities, relating to our acquisition of additional property, plant and equipment for the nine months ended December 31, 2005 and 2004 was $184 million and $130 million. During the nine months ended December 31, 2005, we invested $418 million in liquid mutual funds, $9 million in non-current deposits with corporations, and redeemed mutual fund investments of $193 million. We also withdrew $1 million of non-current deposits placed with corporations. During the nine months ended December 31, 2004, we invested $11 million in non-current deposits with corporations, $56 million in liquid mutual fund units and redeemed mutual fund investments of $32 million.

Loans to employees increased by $1 million during the nine months ended December 31, 2005 while they decreased by $1 million during the nine months ended December 31, 2004. We provide various loans primarily to employees in India who are not executive officers or directors, including car loans, home loans, personal computer loans, telephone loans, medical loans, marriage loans, personal loans, salary advances, education loans and loans for rental deposits. All of these loans, except for the housing and car loans, are available to all of our employees, who are not executive officers or directors, in India. Housing and car loans are available only to mid-level managers and senior managers. The loan program is designed to assist our employees and increase employee satisfaction. These loans are generally collateralized against the assets of the loan and the terms of the loans range from 1 to 100 months. During fiscal 2004, we discontinued fresh disbursements under several of these loan schemes including housing and car loans. In the aggregate, loans to employees represented approximately $25 million as of March 31, 2005 and December 31, 2005.

Net cash provided by financing activities for the nine months ended December 31, 2005 was $10 million. This primarily comprises $101 million of cash raised by issuance of common stock on exercise of stock options by employees offset by dividend payments of $91 million. Net cash used in financing activities for the nine months ended December 31, 2004 primarily comprised $222 million of dividend payments offset by $67 million of cash raised by issuance of common stock on exercise of stock options by employees. Dividend payments during the nine months ended December 31, 2004 include a special one-time dividend of Rs. 25 ($0.56) per equity share paid in June 2004. As of December 31, 2005 we had contractual commitments for capital expenditure of $49 million. These commitments include approximately $38 million in domestic purchases and $11 million in imports and overseas commitments for hardware, supplies and services to support our operations generally, which we expect to be significantly completed by June 2006.

We have provided information to the public regarding forward-looking guidance on our business operations.

Reconciliation between Indian and U.S. GAAP

All financial information in this Report is presented in U.S. GAAP, although we also report for Indian statutory purposes under Indian GAAP. There are material differences between financial statements prepared in Indian and U.S. GAAP. The material differences that affected us are primarily attributable to U.S. GAAP requirements for the:

• accounting for foreign exchange forward contracts;
• amortization of intangible assets; and
• deferred taxes arising due to GAAP differences

Reconciliation of Net Income

(Dollars in millions)

Nine months ended December 31,

2004

2005

Net profit as per Consolidated Indian GAAP

$

295

$

403

Forward contracts - marked to market

(4)

-

Amortization of intangible assets

(1)

-

Deferred taxes arising due to GAAP differences

2

-

Net income as per U.S. GAAP

$

292

$

403

Quantitative and Qualitative Disclosures about Market Risk

General

Market risk is attributable to all market sensitive financial instruments including foreign currency receivables and payables. The value of a financial instrument may change as a result of changes in the interest rates, foreign currency exchange rates, commodity prices, equity prices and other market changes that affect market risk sensitive instruments.

Our exposure to market risk is a function of our revenue generating activities and any future borrowing activities in foreign currency. The objective of market risk management is to avoid excessive exposure of our earnings and equity to loss. Most of our exposure to market risk arises out of our foreign currency accounts receivable.

Risk Management Procedures

We manage market risk through treasury operations. Our treasury operations' objectives and policies are approved by senior management and our audit committee. The activities of treasury operations include management of cash resources, implementing hedging strategies for foreign currency exposures, borrowing strategies, if any, and ensuring compliance with market risk limits and policies.

Components of Market Risk

Exchange rate risk. Our exposure to market risk arises principally from exchange rate risk. Even though our functional currency is the Indian rupee, we transact a major portion of our business in foreign currencies, such as the U.S. dollar, the United Kingdom Pound Sterling and the Euro. The exchange rate between the rupee and these currencies has changed substantially in recent years and may fluctuate substantially in the future. Consequently, the results of our operations are adversely affected as the rupee appreciates against dollar and other foreign currencies. For the nine months ended December 31, 2005 and 2004, U.S. dollar denominated revenues represented 78.8% and 78.3% of total revenues. For the same periods, revenues denominated in United Kingdom Pound Sterling represented 8.1% and 6.5% of total revenues while revenues denominated in the Euro represented 4.5% and 4.9% of total revenues. Our exchange rate risk primarily arises from our foreign currency revenues, receivables and payables. We use derivative financial instruments such as foreign exchange forward and option contracts to mitigate the risk of changes in foreign exchange rates on accounts receivable and forecasted cash flows denominated in certain foreign currencies. We held foreign exchange forward contracts of $353 million and $15 million as of March 31, 2005 and December 31, 2005 respectively. As of December 31, 2005, we held foreign currency option contracts of $26 million and range barrier options of $238 million, Euro 6 million and United Kingdom Pound Sterling 6 million. The forward contracts typically mature within one to twelve months, must be settled on the day of maturity and may be cancelled subject to the payment of any gains or losses in the difference between the contract exchange rate and the market exchange rate on the date of cancellation. We use these derivative instruments only as a hedging mechanism and not for speculative purposes. We may not purchase adequate instruments to insulate ourselves from foreign exchange currency risks. The policies of the Reserve Bank of India may change from time to time which may limit our ability to hedge our foreign currency exposures adequately. In addition, any such instruments may not perform adequately as a hedging mechanism. We may, in the future, adopt more active hedging policies, and have done so in the past.

Fair value. The fair value of our market rate risk sensitive instruments approximates their carrying value.