高知特 (CTSH) 2008 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Cognizant Technology Solutions second quarter 2008 earnings call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session.

(OPERATOR INSTRUCTIONS). Thank you. I would now like to turn the conference over to Hannah Sloane from Financial Dynamics. Please go ahead.

Thank you, operator and good afternoon, everyone. By now, you should have received a copy of the Company's second quarter 2008 earnings release. If you have not, please call our offices at 212-850-5600 and we will send you a copy. The speakers we have on today's call are Francisco D'Souza, President and Chief Executive Officer, and Gordon Coburn, Chief Financial and Operating Officer, of Cognizant Technology Solutions.

Before we begin, I would like to remind you that some of the comments made on today's calls and some of the responses to your questions may contain forward-looking statements. These statements are subject to the risks and uncertainties as described in the Company's earnings release and other filings with the SEC. I would now like to turn the call over to Francisco D'Souza. Please go ahead, Francisco.

Thank you, Hannah. Good afternoon, everyone. Thank you for joining us today for Cognizant's second quarter 2008 earnings call. I'd like to do three things this afternoon. First, provide overview of the highlights of second quarter results. Second, discuss the trends we've seen, particularly relating to the demand environment for our services in light of the economic climate. And finally, put some color around our guidance for the third quarter and the remainder of 2008. As usual, I will be joined on today's call by our Chief Financial and Operating Officer, Gordon Coburn.

Our financial results for the second quarter of 2008 exceeded our prior guidance and demonstrated continued industry-leading growth, despite a very difficult macroeconomic environment during the second quarter. In addition, as Gordon will discuss in a few minutes, most of our operating metrics remained strong during the quarter. While we delivered solid performance in the second quarter, the continuing deterioration in the economy in the latter part of Q2 and in the first part of Q3 has led us to reduce our outlook for the full-year 2008.

90 days ago when we provided our prior 2008 outlook, we were seeing pressure in portions of the financial services sector, but the remainder of our portfolio continued to be stable. We also noted during our last earnings call that in difficult economic times, clients are likely to increase their offshore spending in order to get more done with the same or fewer budget dollars. When we look at our actual results in Q2, the good news is that our financial services portfolio saw improved stability, actually growing slightly above the Company average on a sequential basis.

However, as the quarter progressed, we began to see the impact of the economy affecting clients across other industries. While this trend in Q2 was most clearly evident in the healthcare segment, anecdotal evidence that we have from conversations with customers outside of healthcare and financial services, indicate the effects of the slowing economy will impact other industry groups during the back half of the year. Due to the spread of caution amongst our client base, we're taking the conservative approach in resetting 2008 guidance to be at least $2.81 billion. While we are disappointed the our full-year performance will be below our prior expectations, we feel comfortable with this revised growth target for 2008 and believe the drivers of demand remain intact in our business.

Cognizant continues to lead our sector in growth, and many business development metrics in our business remain at high levels, both in relative and absolute terms. Our pipeline of large deals is strong and in about 90 days, we have had a number strategic high-profile competitive wins. As we discussed on our last call, client satisfaction continues to increase and we see opportunity with our base of over 500 clients as they continue to globalize their businesses and utilize a broader portfolio of our services. In addition, we feel comfortable in maintaining our operating operating margin on non-GAAP basis with a historical target range.

Let me now provide some additional color around our financial and operating results for the second quarter. We exceeded our guidance for revenue generating $685.4 million in revenue, an increase of 33% over the second quarter of 2007 when we recorded $516.5 million in revenue and an increase of 6.6% sequentially from $643.1 million in the first quarter of 2008.

We saw better than expected growth in financial services, which grew 7% sequentially and 29% year-over-year. This may appear counter-intuitive given the headlines we all read, but it is the result of some of our US financial services clients starting to increase the proportion of work they are doing with off shore provider as a way to reduce their aggregate IT and operations costs. These organizations are taking advantage of the opportunity presented by the slow-down to continue to invest in order to enhance their competitive position or cost structure.

Offsetting the relative strength in financial services, our health care segment was weaker than expected, reporting 3% sequential growth and 39% year-over-year growth. I'll provide a deeper look into our healthcare performance in Q2 in a moment. Manufacturing, retail and logistics grew 10% sequentially and 38% year-over-year. And our other segment which includes communications, information, media and entertainment, and high technology grew 7% sequentially and 29% year-over-year.

In terms of geographies, Europe is still showing strength, growing 83% year-over-year and 15% sequentially, and rising to 20% of our revenues from 19% last quarter. This steady growth results from our focused efforts to increase our presence in this geography. Our partnership with Key Systems continues to move forward and the pipeline of joint opportunities is building. Finally as we've been saying for some time, we view IT infrastructure services and business process and knowledge process outsourcing, as significant opportunities since these areas are generally underpenetrated areas from an offshore standpoint.

During Q2 combined BPO and KPO revenues has increased 19% sequentially. Of course, this must be viewed in context since our BPO revenues are still comparatively small. IT infrastructure services also showed strong growth, increasing 15% sequentially. IT IS revenues now represent about 5% of total revenues.

If I can summarize our Q2 results, I would characterize the quarter as one where we continued to see pockets of strength offset by areas of weakness. This phenomenon of strength and weakness at the same time is the result of multiple trends occurring simultaneously in our markets. I would like to now spend a few minutes providing you with detailed qualitative and quantitative information about demand, resulting from these cross-trends and the resulting effect on our outlook.

The first trend is of clients and industries beyond financial services reassessing their budgets, reprioritizing spending and elongating decision cycles as business and consumer confidence deteriorated further. We saw this in particular within healthcare where revenues grew 3% sequentially during the quarter, compared to 10% in the first quarter. A deeper look into our healthcare growth in Q2 reveals that spending amongst our life sciences customers was weak as they pulled back plans for discretionary spending, due to the economic environment and also the tremendous pressures facing that industry, resulting from drug 50 government and regulatory issues.

As we look forward to the remainder of the year, we also anticipate slower growth within the payer segment of healthcare, largely driven by one of our top five clients in the payer sector who has informed us of plans to scale back spending significantly in Q3 and Q4,'s as a result of business pressures they are currently facing. While they are -- while they expect to reduce spending, it is also worth noting that we continue to represent a substantial proportion of this company's offshore spending. And we expect them to continue to remain solidly in our top five client list.

In financial services, although we saw a recovery to some extent in Q2 compared to Q1, we continue to maintain a cautious view for the remainder of the year, principally due to the turmoil in that industry and the likely possibility that the economic situation will extend beyond the US to impact our customers in Europe. In terms of other industry sectors, we are also taking a conservative view for the rest of the year as we anticipate that the effects of the slowing economy will impact each of our segments.

However, offsetting this first trend are several trends which by contrast are driving demand for our services. The second trend we are seeing in the market is the shift towards increased spending with offshore providers as a result of intensified pressures to find cost efficiencies. In the second quarter, we witnessed this trend amongst our financial services client base where we saw growth slightly above the Company average and ahead of our earlier expectations.

As an example, one mid-sized US bank with whom we have been working since December 2005, recently expanded its relationship with us in order to significantly reduce its costs. Our engagement with this client had previously been limited to individual application development projects with no long-term continuity. Eager to find a solution for enhancing their margins , the bank has decided to outsource the maintenance of IT application portfolio to Cognizant after we helped identify savings opportunities worth several million dollars. In addition to providing cost savings, Cognizant will work with the bank's technology and operations group to enhance product development as well as to enhance business agility and speed-to-market. We continue to see strong evidence that firms like Cognizant will benefit from this trend as companies across industry groups come under significant pressure and look to increase offshore IT and other services during difficult economic times.

The third trend in the market is towards increase adoption of offshoring in new service areas beyond the traditional IT outsourcing, in particular, BPO and KPO and IT infrastructure services. As I mentioned earlier, growth during Q2 in both our BPO and KPO, and our IT infrastructure services lines was strong. In addition to being strong revenue opportunities in their own rights, IT IS and KPO and BPO are proving to be opportunities for us to establish relationships with clients with whom we may not already have an established relationship in the IT area.

To provide you some color, during the quarter, the BPO practice won a number of engagements which include providing application processing, policy management, account management and sales support to a major insurance carrier, providing manual claims processing to a leading pharmacy benefits processing business, and providing retail point-of-sales support for a leading media retail outlets network of hundreds of outlet stores across the US. We've also made considerable headway in IT infrastructure services which represented 5% of revenues in the second quarter. We are seeing success by leveraging our on-target platform from the AimNet acquisition with our client. This provides our client with an integrated management platform of tools, processes and automated work flow.

During the first half of 2008, we won a number of deals including implementing a multi-tower infrastructure management and support for a healthcare business processes provider, implementing a server management--excuse me, server infrastructure management and support for a worldwide research-based pharmaceutical company, and providing support for a key data center consolidation initiative for a leading provider of merchant processing services. The final trend we're seeing in the market is a reaction by clients to the secular changes that they're experiencing in their respective industries, unrelated to the current economic environment. Secular pressures often lead to the need for consulting services, process design services, and deployment of new technology in order to addressee involving market dynamics.

As a result of this trend, we continue to see growth in our application development services which grew 32% versus the second quarter of 2007, and also across a range of our horizontal services including areas such as ERP and testing. As an example, a retailer that is facing dramatic changes in this market, and needs to aggressively modernize, recently expanded its relationship with Cognizant to include many mission-critical applications beyond application support. We're helping them to deliver strategic initiatives such as digital content distribution to make their company more competitive in their changing marketplace.

The net result of all of these trends is that while we anticipate continued lumpy demand over the rest of the year due to the impact of the economy and other industry pressures on our clients, we remain confident about the fundamental drivers of demand for our services. An indication of this is our pipeline of large deals which continues to remain strong.

Now, let me turn to guidance. In light of the weakening economy, we are no longer tracking to our prior forecast of approximately 38% revenue growth for the full year. Our prior outlook was based on the prevailing business and economic conditions three months ago. Although our financial services portfolio stabilized, we are seeing a further weakening in the economy and these economic pressures are affecting our clients across other industries.

Given the decline in business and consumer confidence that have occurred, we now have a more conservative view of the economic outlook and have adopted a correspondingly more conservative approach to Q3 and the full-year 2008. In the interests of caution, we have reduced our outlook and now expect revenues of at least $723 million in the third quarter, and $2.81 billion for the full year of 2008.

I feel it's important to put our second quarter results and expected 2008 results into context. Our second quarter sequential growth and guidance for Q3 are at the top of our peer group. We believe that relative performance compared to our peer group is the best indicator of our competitiveness. In this tightening environment, we continue to increase our market share and we are still benefiting from the investments that we have made over the years to gain advantage in the market.

As we look forward, ur objectives for the remainder of 2008 and beyond are clear. While we cannot affect what is outside of our control, we are focused entirely on running our Company in a prudent manner while at the same time making the necessary investments to ensure that we emerge from this period of economic uncertainty as a stronger, more competitive organization. Our priority in going forward are as follows. First, we will maintain our focus on our bottom line. We will continue to optimize cost efficiencies and increase utilization during the remainder of the year, maintaining target operating margins within the 19% to 20% range on a non-GAAP basis.

We believe we can deliver this while still protecting our core areas of investment in newer services, maintaining our geographic growth, and deepening our vertical industry capabilities. Second, working with our customers to demonstrate proactively how offshoring across IT -- IT infrastructure services and BPO and KPO can be an effective tool to reduce costs and deliver more during tough economic times. And, finally, ensuring that we maintain our investments in areas that will generate growth and position us best for when the economy recovers.

To that end, we continue to remain focused on building distinctive positions in each of the markets that we serve and deepening our consulting and domain capability in each of the industries we serve. For example, during the second quarter, we completed the acquisition of Los Angeles based management and technology consulting firm Strategic Vision Consulting or SVC, which has strengthened and accelerated our presence in the media and entertainment vertical. SVC has a specific focus on studios and offers services in media asset management, digital asset management, physical asset management, licensed electronic downloads, rights management, artist payments, and financial systems. This is a complimentary fit since our service offerings and global delivery model will allow SVC to immediately expand its footprint and wallet share with its current studio clients.

In summary, as we look to the full-year 2008, while we are disappointed that our full-year performance will be below our prior expectations, we remain optimistic about our ability to best position the business for future growth, continue to outpace the industry average, and emerge from the economic environment in an even stronger position. Our pipeline of new business with existing and new customers is robust. The trends I enumerated earlier demonstrate that while some clients are slow to make decisions and tightening their spending, there are opportunities from which we can benefit as many clients turn to Cognizant as a solution for optimizing their cost efficiencies and helping them to adapt to the changing industry environment.

While these trends show signs of persisting, Cognizant will remain well-placed to continue to grow its business. Now, I'll turn the call over to Gordon who will walk you through our financial and operating results in greater

Thank you, Francisco, and good evening to everyone. I would like to provide some additional information on the second quarter and then discuss our financial expectations for the third quarter and remainder of 2008. As Francisco mentioned, quarterly revenue grew 6.6% sequentially and 33% year-over-year.

During the second quarter, our financial services segment which includes our practices in insurance, banking and transaction processing, grew by over $71 million year-over-year and represented 45.8% of revenue for the quarter. Healthcare grew by almost $46 million and represented 24% of revenues. Retail, manufacturing and logistics grew by over $29 million and represented 15.6% of revenues for the quarter. The remaining 14.6% of our revenues came primarily from other service oriented industries of communications, media, and new technology, which grew by over $22 million compared to Q2 of last year.

For the quarter, application management represented 53% of revenues, and application development was 47%. Both services continued to grow significantly in Q2. Application management grew 34% year-over-year and over 8% sequentially. Development grew 32% year-over-year and almost 5% sequentially. The sequential strength in application maintenance, we believe was driven by clients seeking to optimize efficiencies on non-discretionary spending due to budget concerns.

During Q2, just over 78% of revenue came from clients in North America. And for the first time, Europe made up over 20% of total quarterly revenue at 20.3%. 1.5% of our revenue came from the Asian market. Our European grew almost 15% sequentially and over 83% year-over-year for the quarter as a result of our continued investment in that region.

We had a gross addition of 63 new customers during the second quarter. We closed the quarter with 520 active customers. During the quarter, the number of accounts which we consider to be strategic and have the potential to ramp up to at least $5 million to more than $50 million in annual revenue increased by five, bringing our total number of strategic clients to 118.

Turning to costs. On a GAAP basis, costs of revenues exclusive of depreciation and amortization, increased about 30% for the quarter as compared to the second quarter of 2007. Second quarter cost of revenues included approximately $4.7 million of stock-based compensation expense, as well as $2.1 million of non-cash expenses related to the accounting for Indian fringe benefit tax expenses recovered from employees related to the exercise of stock options.

As discussed during your call in May, the Indian fringe benefit expense represents the accounting impact of conversion of a portion of the taxation in India from employee stock option -- of employee stock option gains from the employee income tax to a Company-paid fringe benefit tax which is then recovered from the employee. We are treating the tax payments made by Cognizant as an operating expense and the equivalent amounts recovered from the employee as option exercise proceeds which are booked directly to equity. There is no cash impact to the Company from this taxation.

The increase in cost of revenues is primarily due to additional technical staff, both on-site and offshore, required to support our revenue growth. We increased our technical staff by approximately 1100 during the quarter and ended the quarter with approximately 55,500 technical staff. Second quarter SG&A, depreciation and amortization expenses were $184.9 million on a GAAP basis, up from $133.5 in the second quarter of last year. GAAP SG&A expenses in Q2 included approximately $5.7 million of stock-based compensation expense and $3.8 million of non-cash expense related to the Indian fringe benefit taxes.

GAAP operating income for the quarter increased 32% to $119.7 million, from $90.7 million in the second quarter of 2007. On a non-GAAP basis, which excludes the impact of $10.5 million of stock-based compensation expense, and $5.9 million of non-cash fringe benefit tax expense, operating income for the second quarter was $136.1 million, up 35.8% from last year. Our GAAP operating margin was 17.5% for the quarter. And our non-GAAP operating margin, which excludes stock-based compensation expense and stock based non-cash Indian fringe tax expense, was 19.8% for the quarter within our target range of 19% to 20%. The average rate for the Indian rupee was approximately 41.6 -- what was approximately 41.6 in the second quarter versus 39.7 in the first quarter of 2008.

As Francisco mentioned, we're committed to maintaining our investments in the business in order to generate growth and to position us best for when the economy recovers. During Q2, we accelerated several of our investment programs, mostly the hiring of client-facing talent and industry expertise. In addition to the benefit of the weakening rupee, we partially funded these accelerated investments by implementing salary increased in a phased manner with increases for a significant portion of our population occurring at the end of Q2 rather than beginning of Q2.

Interest income for the first quarter was $4.9 million, compared to $6.5 million in the second quarter of 2007 and $6.2 in the first quarter of this year. Sequential interest income decreased primarily due to a slight decline in the average cash and investment balances, as well as a meaningful decline in short-term interest rates in the United States. We had a $500,000 foreign exchange loss during the quarter.

Our GAAP tax rate for the second quarter was 16.3%, down slightly from the 16.4% tax rate in Q1 of 2008. We expect the full-year tax rate to be around 16.3%. As has been previously discussed, certain of our tax holidays were scheduled to end in March 2009.

The Indian government recently passed into law a one-year extension offer the STPI tax holiday. Accordingly, these holidays are now scheduled to end in March 2010. Our diluted share count for the quarter was 299.3 million, up slightly from 299.1 million in Q1 of 2008.

Turning to the balance sheet. Our balance sheet remains healthy. We finished the quarter with just over $713 million of cash, short-term and long-term investments, up from $645 million at the end of March.

During the second quarter, operating activities generated approximately $75 million of cash. Financing activities generated approximately $39 million of cash from the proceeds of options exercised and related tax benefits, as well as our employee stock purchase program. In addition, we spent approximately $32 million for capital expenditures during the quarter and approximately $12 million towards acquisitions, primarily the purchase of sTrategic Vision Consulting.

Based on our $583.1 million balance on June 30, we finished the quarter with a DSO, including unbilled receivables, of 77 days, compared to 71 days for the same period in 2007 and 73 days in the first quarter of 2008. During Q2 excluding unbilled receivables, our DSO was approximately 70 days. The increase in DSO during the second quarter was primarily driven by UK customers, a few large customers in our healthcare segment, as well as the general trend of larger customers paying bills, a bit slower due to the economy.

The quality of our receivables portfolio remains quite strong. Our unbilled receivable balance was approximately $57.7 million at the end of the second quarter, which was down $9 million from March 31. Approximately 56% of our June 30 unbilled balance was billed in July. During the second quarter overall, 25.7% of our revenue came from fixed-priced contracts, down from 26.8% in the first quarter of 2008 and up from 25.3% in the second quarter of last year. When we look at the mix by solution type during the second quarter, 31% of our development revenue and 21% of our maintenance revenue came from fixed price contracts during the quarter.

Turning to head count. At the end of the second quarter, our worldwide head count including both technical, professionals and support staff totalled approximately 59,300, up over 1300 people from March 31 of this year and up almost 14,000 people from Q2 of 2007. Turnover, including both voluntary and involuntary, was approximately 15% annualized during the second quarter. Attrition was down from approximately 17% in Q2 of last year.

As you may remember, we hired a large number of new college graduates at the end of Q4 2007 which caused a decline in utilization levels in the first quarter of this year. As we absorbed these new college graduates into our practices during the second quarter, our offshore utilization rates began to improve, increasing to approximately 55% from 53% in the first quarter. Offshore utilization, excluding recent college graduates who were in our training program in the quarter, was slightly over 70%.

On-site utilization was approximately 88% during the quarter. At the end of Q2, we had approximately 7,000 unbilled people in our training programs. Throughout the remainder of 2008, we will be further increasing our utilization rates to take advantage of scale economies and to leverage our historically heavy overinvestment in bench resources and the large number of trainees we had on board coming into the year.

I would now like to comment on growth expectations for the third quarter of 2008 as well as the full year. As Francisco has mentioned, we've adjusted our full-year guidance to reflect increased economic uncertainty we have seen this summer. Our pipeline remains robust and we continue to win significant projects. However, this is muted by a tighter IT spending environment than we saw just three months ago.

We continue to focus on working with our clients to leverage the advantages of our business model to help them through these challenging economic times. Although we are disappointed that we must revise our full-year guidance, we are pleased that our business continues to grow at a healthy pace despite today's economic turmoil. For the third quarter of 2008, we are projecting revenue of at least $723 million.

This represents sequential growth of at least 5.5%. We have significant revenue visibility into our third quarter guidance due to the high level recurring revenue and long-term nature of our customer relationships. In fact today, we have customer commitments for well over 90% of our third quarter revenue guidance.

For the full year, we continue to expect industry leading revenue growth. Based on current conditions and client indications, we expect revenue of at least $2.81 billion. As has been typical in past years, we expect the majority of our growth for the remainder of 2008, will come from the ramp-up of clients that we've won over the past months and years. During the remainder of 2008, we intend to continue to closely monitor our spending and assuming no material change in the value of the rupee, expect our operating margin to remain in the range of 19% to 20% before the impact of equity-based compensation and non-cash fringe benefit tax expense related to stock option exercises. This is in line with our historic margin-level goals.

With this expected level of revenue growth and our expected operating margins, we are currently comfortable with our ability to deliver in Q3 GAAP EPS of $0.37 and non-GAAP EPS of $0.41, excluding estimated stock-based compensation and non-cash stock-based fringe benefit tax expense of $0.04. This guidance includes the anticipation of a Q3 share count of approximately 3.3 million shares, a tax rate of 16.3%, and an operating margin within our target range of 19% to 20% excluding stock-based compensation and fringe benefit tax.

For the full year 2008, based on current business trends, we currently project GAAP EPS to be at least $1.44. And full-year non-GAAP EPS to be at least $1.61 excluding $0.17 of stock-based compensation and fringe benefit tax expenses. This full-year guidance includes the anticipation of a share count of approximately 300 million shares. With that, we would now like to open call to questions. Operator?

(OPERATOR INSTRUCTIONS.) We'll pause for just a moment to compile the Q&A roster. Your first question comes from Ed Caso with Wachovia. Your line is open.

Hi. Good afternoon. Your changing of your adjectives from approximately to at least, does that suggest to us that you're giving us the worst-case scenario or close to the worst-case scenario?

When we gave the guidance of approximately -- three months ago that was based on -- this is our best guess of where we are going to land. When we have changed the language to at least, we look at that as we're comfortable achieving this level. It definitely is an intentional change in language.

Can you quantify the impact of Indian [Mac] bank and when that hit in receivable exposure?

We--obviously, it had a first phase of ramp down last year. But we have been still been doing a fair amount of work for them. We are fully reserved for any cash that is not collected in Q2. We don't have any exposure, coming into Q3 on the receivables at Indy Mac.

Last question, are you extending start dates?

Can you clarify that a little bit?

For the offers you made a year ago -- for those coming on now, have you pushed out start dates?

In terms of the college recruits that we made offers to a year ago who started joining us into May of this year and will continue into 2009, clearly with the reduction to revenue guidance, we won't need as many people as we originally thought. We still intend to bring all those people on.

There's no question about that. However, the timing of it will certainly be spread out over a longer period of time which is something you're seeing very common in the industry right now.

Your next question comes from Ashwin Shirvaikar with Citigroup. Your line is open.

Thanks. This question on the cost side, how should we think about the cost side of the equation with the new lowered growth rate? How does it affect -- to some extent you answered the on-boarding. But does it affect people's compensation expectations and so on?

Well the biggest impact obviously is that we won't hire as many people as we planned. Yes, we brought our guidance down, but we're still growing at a very, very healthy pace. We will continue to add people during the year, but certainly not as many as we originally planned. The biggest lever on the cost side is controlling the head count growth.

Okay. But in terms of compensation expectations, people are expecting what level of compensation increase now?

That's all done. The compensation increases for this year are all rolled out. That came in pretty much where we planned in that 10% to 12% offshore. Just be clear, that's completely done.

And can you--could you give the number for what pricing you're seeing? Plus what was the CapEx? Those two.

Sure. In terms of pricing, the best way to phrase it, it's stable. We're actually seeing the competitors be quite rational on pricing. Is there a big upward bias? Certainly, not in this economy. But it is stable pricing environment.

CapEx for the quarter was about $32 million for the full year, given we're going slower. CapEx will probably come in below our original target of $250 million. How much below, we haven't fully worked that out. Obviously, a lot of it is related to construction. The stuff underway, obviously we'll finish up on schedule.

Okay. And any difference between banking versus financial service versus insurance?

Clearly the biggest pressures we're seeing are in BFS part of it, so the banking and financial services as opposed to insurance. Although we are, as we look to the rest of the year, being more cautious. And as we look -- as we provided the revised guidance, we are also anticipating that some of the softness rolls over into insurance and in fact, into our other industry sectors as well.

The other part of it was that when we talked with you last quarter, we hadn't yet started to see the impact of the economy and so on, on financial services customers in Europe. We're now starting to see some signs that that -- that there could be impacts of the economy and customers in the financial services sector, and other sectors in Europe.

Okay. Thank you.

Your next question comes from Rod Bourgeois with Bernstein. Your line is open.

Hey, guys. I want to clarity some of the assumptions in the guidance. The specific question is, is your guidance assuming that current macro conditions remain in place? Are you assuming that there might be macro issues worsening in the second half? In other words, do you see risks that you could have to lower your guidance again if macro issues flange up again in the second half?

Rod, well first, you may know in the interest of caution is that macro conditions will worsen slightly over the course of the rest of the year. We're not assuming that there's going to be a major worsening, but we're expecting that things will deteriorate. As I said in my comments, what we saw in Q2 was the impact in healthcare. We're assuming over the course of the rest of the year that we'll see the impact in our other industry sectors as well.

And another way to think about the way we've framed our guidance. If you look on a quarterly basis over the next couple of quarters, what we tried to be conservative in forecasting out for the rest of the year. The way we looked at it, in addition to looking at our core operating metrics and pipelines and forecasts and those kinds of measures that we look when we look out over the next couple of quarters. The other thing we did was we said, in general even through this period of economic turmoil, we've tended to have pretty good visibility one quarter out. We feel reasonably good about our Q3 guidance. The at least $723 million for Q3 that we mentioned.

In Q4, we've taken an appropriately conservative view in our view--in our minds as we think about the potential of deterioration in the macro environment. Our implied revenue growth for Q4 is quite modest. One way to think about it is that in each of the last nine quarters, so for more than two years, we've added more revenue in each of those quarters. Than our guidance implies we lied in the fourth quarter.

The reason we did that is -- our belief is that the economy is going to stay tough for the rest of the year. We want to be prudent in our expectations.

I got it. And then when you look at the guidance from another angle, can you state on upper end to your revenue growth prospects for the year? Alternatively stated, is the 35% revenue growth range still a possibility for 2008, given that you seem to be adding some buffer for a weakening economy?

We've not put an upper end, but obviously it is a challenging economy out there as you read about it in the papers everyday. We think we've been prudent in setting this new guidance.

All right. And then in terms of the margins, it looks like you're reinvesting all of the rupee-based margin upside back in the business. Is that the case? Or are you seeing that rupee-based margin upside being offset by certain margin pressures? What is happening on that front?

For Q2, we invested back into the business. Now remember, the average rate for Q2 is less than the current spot rate, so there is more rupee benefit in Q3, assuming that rupee holds. As I mentioned in my prepared comments, we did move a significant portion of this out -- the timing of the salary increases to the end of the quarter. That hits us in Q3.

The way that gets funded is by the -- assuming the rupee stays where it is, utilization will go up materially in Q3. We have certainly more room to significantly take up utilization. If you look at the sequential increase in SG&A spend, it was very significant in Q2 and it will not be as significant in Q3. We accelerated a bunch of SG&A client-facing investment and -- so we won't have that same bump in Q3.

Right. What I'm trying to ascertain here, is there anything worrisome happening on the margin front that you're using the rupee to offset?

No. On the margin side, most things have actually been going in our favor. There is nothing significant that has been going against us.

Okay. In other words if the rupee were to appreciate some here, you wouldn't need to take down your margin range or your EPS guidance? You would have the ability to adjust to that potentially?

We have a lot of leverage in our expense base. Unless there was pa drastic movement in the rupee, I'm not particularly concerned about our achieving our margin targets.

All right. Thanks, guys.

Your next question comes from Karl Keirstead from Kaufman Brothers. Your line is open.

Hi. Good afternoon. I've got two questions. One is, if you look at your guidance, your fourth quarter revenue assumption would be about $760 million. If I assume after that, that the growth will be a normalized 5%, 6% on a sequential basis, I get to an '09 growth rate of about 23%, 25%. Is that a good working assumption from here?

Karl, it is just way too early to know. A lot of it depends on what's happening with the economy. As customers go through some difficult, financial transitions, how quickly do they leverage offshore to adjust to their new cost structure. We haven't even begun discussions with clients about 2009 yet.

But the good news is penetration levels are still very low for offshore. We provide part of the solution on a long-term basis for clients adjusting to potentially a new economic model. But at this point, we're more focussed on 2008 and making the investments so in 2009 and beyond, we continue to have industry-leading growth.

Fair enough. A second question, it seems you're talking little bit more in your prepared remarks about investing and enhancing your domain and consultings expertise and expanding your offering into BPO and KPP and IPO for that matter. Can you talk a little bit about what is happening in the client base that might be incenting you to adjust the business model if you would like? That perhaps you were not seeing six months ago? It sounds like perhaps there is something other than the cyclical downturn which everybody is seeing. Perhaps you can offer some thoughts.

First of all, all of these investments that we've -- that you have referred to and that I referred to in my prepared comments, are not new. We've been systematically been building out industry domain expertise for years now in each of the industries that we serve. We've updated all of you periodically on our efforts to do that with the acquisitions like SBC and Market Rx and life sciences a few quarters ago. We'll continue to do that.

We think that it is very important as we look forward to not just be able to provide our clients with good technology solutions, but to be able to put an industry lens on top of that so that we provide solutions to clients' business problems and we can be more business relevant. We seek to be strategically relevant when we have our dialogs with customers. In terms of industry domain expertise, that's been going on for years now. It is something that we will continue to do and systematically build out across each of the industries that we serve.

In terms of BPO and IT infrastructure services, again, these are service lines that we've been talking about for several quarters now. We think that they both represent in their own right, strong revenue opportunities. Particularly the vertical business process outsourcing that we've talked about for some time. And ITO which is significantly underpenetrated from an offshoring perspective. The reason that we are -- that I highlighted those on the call today, first, because we're starting to see some real traction with infrastructure services, for example, now approaching 5% of our revenues. But also because we're starting to see clients really looking to -- looking beyond the traditional application space to these other areas. In a tough economic environment to say, how can I expand my use of offshoring and these are two logical -- BPO and KPO and IT infrastructure services are logical places where they're turning.

Great. Thank you for taking my questions.

Thanks, Karl.

Your next question comes from Moshe Katri from Cowen. Your line is open.

Thanks. If you look at the June quarter on a monthly basis, was the trends similar to what you've in March? Started strong, ended weaker? And then, so far during the month of July, did you see a further deterioration and demand in fundamentals?

No. It was a different situation than Q1. In Q1, March was very bad. In Q2, the issue was June was not very good.

What we were counting on was coming -- getting strong momentum coming out of Q2 going into Q3, more just a steady quarter. Different dynamics than Q1 where things really fell off the map in March, But we clearly did not have the momentum that we were hoping for, coming out of Q2.

And is that extended into the month of July as well?

We haven't closed our books yet for July.

And then, you're talking a lot about a difficult environment. Have you seen any significant delays in project starts or anything in terms of meaningful project cancellations?

I pointed out a couple of situations, Moshe, during my prepared comments. I think in Q2, we saw life sciences customers in particular, pausing and reassessing, putting some of their plans on hold. Then specifically for the rest of the year, one of our payer customers, a large customer, has informed us of plans to cut back spending quite significantly over the third and fourth quarters. We are seeing some delays and we are seeing some cutbacks. Yes.

Okay. Is there any way to quantify those? What impact from that customer will have on the second half in terms of revenues? And just to be clear, based on management's bonus compensation structure, I think the magic number is about 35% revenue growth. I think below that management will not get paid a bonus or bonuses? Is that correct?

That's correct on the long-term compensation program, not on the annual bonus. But the long-term, that is correct.

Okay. Can you also quantify the impact from that payer on second half revenues?

It's built into the guidance.

It is built into our guidance. It is not our place to talk about a specific client.

Okay. Thanks.

Your next question comes from Julio Quinteros from Goldman-Sachs. Your line is open.

Great. Thanks. Why don't you go back to one specific area. If you guys could talk a little bit about trends in ERP spending, especially coming out of the SAP quarter over the last couple of days. I'm trying to get a sense for how those things tie together. Because it sounds like your commentary around ERP -- still sounds like it is relatively robust. Maybe if you could put any numbers around of what that growth rate looks like, that would be helpful.

We had a good quarter with ERP, just looking at the numbers here. Both the SAP and the Oracle businesses grew nicely. Just to give you couldn't context, both of them grew sequentially better than 20%. On a year-over-year basis, both of them grew north of 50%. We continue to see strong growth in both of those.

It's being helped a little bit by our key systems relationship. There's some SAP work we're doing there as well. We have a strong -- most of our customers have a strong install base of SAP and Oracle, so we continue to do work for them. I would say our progress there has been strong and we're pleased with good sequential growth in both of those.

Important things to remember is a lot of the work we do is maintenance enhancements, rollouts, so there is not always a direct correlation between new license sales and our revenue in ERP. A lot of it is related to do the install base, moving the work to support that install base offshore.

Got it. What are your revised assumptions now, having had two systems under your wings for a little bit? What are you thinking about there in terms a revenue run rate or contribution from T-Systems going forward?

The real key is the new deals we're jointly going after. We're starting to go after some meaningful deals. As you know, larger deals in Europe take time.

When I think about T-Systems being a growth driver, as I said, when we did the deal and on the first quarter earnings call, we do not expect it to be a growth driver in the second half of this year. Where we really think it can kick in is next year if things go the way we hope.

Okay. Great. Finally, just in terms of this proverbial question about how we know this is really the bottom in guidance. More to you, Gordon, given that this all falls in your lap here. Where are we at, in terms of what really needs to be done to actually hit the number for the fourth quarter? More than anything else to get to the full-year number of $2.8 billion at this point. Can you give us a sense in terms of -- do you actually have to win new stuff to get to those numbers? The ones you're currently projecting here? Or is there some other way of thinking about what it takes to really hit this number from here?

You're asking the right questions, Julio. In Q3, we're well enough into it and this is not a business where you wait until the last day of the quarter to sign a contract. Q3, we understand where we're going to land. Q4 because of all of the uncertainty out there, you back-calculate our guidance, you will see in Q3. we're guiding to go 5.5% sequential growth.

And Q4, we put some cushion in there and we guided to little bit less, about 5% sequential growth. Because there's a little bit more of an unknown. We think we have sufficient cushion in there. Because remember, the part you care about is that last -- X percent of revenue. There is a core part that is ongoing. It is a uncertain time, but we've built that into our model.

And just looking maybe back, as you guys look at your business now and compare where we were at the beginning of the year and where we are now. Typically, I think we had assumed that maybe half of the business was really discretionary, because it was (inaudible) maintenance or something along those lines. Is there just some sense in terms of what things can really be turned off and what needs to run its course? And maybe some percentages around what ultimately is discretionary in your model?

The issue is less what can be turned off. We have a couple of accounts where, stuff is getting ramped down a little bit. But the bigger issue is the growth and how quickly are people moving new projects offshore. That can impact both maintenance and development.

Now, obviously you saw it in the sequential growth numbers of -- that maintenance grew a little faster than development which makes sense in a tough economy. The uncertainty in the economy can impact the growth of maintenance. Absolutely. And that's -- an assumption that it will is baked into our guidance.

Got it. Okay. Can you just give us those final metrics on the offshore on-site effort mix and just the standard ones we usually get?

Sure. Just hold on one second. We went very slightly on-site compared to last quarter, but almost unchanged. Pricing on a year-over-year basis is up 1.5%, 2%. Utilization is 88% percent. On-site, 55% offshore.

No surprises in the metrics. The only metric -- when I look at the metrics for Q2, in my mind , the only one I was disappointed in or surprised by was DSO. That was obviously higher than we wanted. We understand why. And we don't view it as a credit risk. Metrics pretty much dropped to where we

Great. Thanks, guys.

Your next question comes from James Friedman from Susquehanna. Your line is open.

Thanks. It is Jamie Friedman at Susquehanna. I wanted to ask first about a balance sheet question, Gordon. When I look at the unbilled revenue as a percentage of the revenue, that actually declined which I see as a healthy trend. But I'm trying to reconcile that with the DSO and the receivables and the percentage of the revenue. How should we think about those two dynamics?

Unbilled is going to bounce around. We had a good size jump in Q1 and it came back down a little bit in Q2. I think about that a little bit differently than DSO. The DSO number we report includes unbilled, and it went up.

It was driven by UK, some healthcare customers, and generally customers paying a little bit slower due to the economy. What we did not see is all of a sudden our really small customers stretch out payments. Where we're seeing slower payments is actually the larger customers which means it is not a credit concern, it's more just we got to get a little tougher on that. Unbilled receivables are going to bounce around.

We continue to bill -- 56% of it, get's billed in July, so that statistic I thought was fine. Will it be up or down next quarter? Always tough to tell. A lot of that depends on when you hit milestones on specific contracts.

I also wanted to ask you about the operating margin. I think the Company is well known for its mantra of governing the operating margin at a certain level and investing in the top line. The gross margins were healthy in the quarter. Is there any update to your thinking at this juncture in the life cycle of the Company? Is there any opportunity to release the operating margins higher, being that the growth is decelerating?

No. You should have no expectation of that. The gross margin was up because we made the decision to phase the timing of the salary increases and to invest very heavily down on client facing and domain expertise. Our SG&A spend went up significantly sequentially, while our gross margin went up due to the rupee and the improvement in utilization. What you'll see in Q3, because I'll have the impact of the salary increases. You will see gross margin come down a little bit, but operating margin remain in the realm of things, relatively steady.

I'll just add to that, Jamie. We're playing for the long-term here. There are still some significant opportunities to invest and capture share of market. We talked a little bit about things like IT infrastructure services and so on and so forth. These are very underpenetrated service offerings. There is still considerable opportunities for us to invest -- we're talking beyond Europe, there are other geographies in the world where we have investment priorities. There is still significant growth opportunities and significant investment opportunities for us as we look forward.

Thank you. Great.

And with that, it is a little bit after 6:00pm. I know people probably want to get home for dinner. Francisco, want to finish up?

Yes. Thanks. And thanks everyone for joining us on the call today. To conclude, we're pleased with our financial and operating performance in our second quarter across the Company. It exceeded our guidance and proved our ability to maintain industry-leading growth, despite the current economic climate. We are adopting a more cautious stance for the remainder of the year, but we remain optimistic about our ability to best position the business for future growth, to continue to outpace the industry average, and to emerge from the economic environment in a strong and defensible position. We'll look forward to talking to you again next quarter. Thank you very much.

This concludes today's Cognizant Technology Solutions second quarter earnings call. You may now disconnect.