Cognizant Technology Solutions Corporation (CTSH) Earnings Call Transcript & Summary

Okay. All right. Great. Well, thank you, everyone, for joining us. My name is Brian Essex. I cover security software with Goldman Sachs, but I have an IT services CFO here with me this afternoon. So very pleased to have Karen McLoughlin, the CFO of Cognizant. Karen, thank you for joining us.

Thank you, Brian.

So I wanted to maybe start off real quick. I saw that you reported earnings last week, and that was very exciting, great stock reaction. But you've been very busy. Perhaps it would be a good idea just to recap the release. It's the first time you've given your initial 2020 guide, and I was a little bit surprised of the stock reaction. So maybe you can kind of put that in context and frame out guidance and your expectations for 2020.

Sure. So as you said, we did release earnings last week, and I think, wrapped up the year on a slightly positive note. Certainly, 2019 overall performance wasn't where we would have liked it to be at the beginning of last year, but we did end the year at 5.2% year-over-year, on a full year basis, constant-currency revenue growth. And in the fourth quarter, it was 4.2% constant-currency growth year-over-year, but we did exceed our fourth quarter revenue guidance. And I think, certainly, as we went through the fourth quarter, we saw some continued strengthening in our North America business versus where it had been earlier in the year. So I think we were very pleased to see that trajectory and the activity and the energy that's coming back into our North America business. So that was good. We did, of course, give our full year 2020 guidance in our call last week. And as we look forward into 2020, we have guided to revenue growth of between 2% and 4% on a year-over-year basis. Constant-currency and reported growth for 2020 at this point are the same. So there's no differences there. But that does adjust for the fact that we are exiting our content moderation business. That will be about 110 basis point impact -- negative impact to growth this year. So I think that will continue to filter in as we go through this year. From a margin perspective, as we look forward to 2020, we have guided, as we talked about last fall, to an adjusted operating margin range of 16% to 17%. We did say that in the first quarter, we'll be slightly below that. We have, as many people know, started ramping up our investments in sales hiring over the last few months. And we will -- we are in the middle of our large transformation program, but a lot of the head count reductions don't take place until later in the first quarter and into the second quarter and into the middle of the year. So we won't get all of the cost-saving benefits until later in the year while we're ramping up investments in sales as we move forward. But I think versus where we were a few months ago and what I see happening in the business, I think folks have really gotten refocused on selling and being in front of clients. And I think, certainly, we are starting to see what I would call a little bit more stability amongst the team. Obviously, we went through a CEO transition last year. And that was the first time we had an outside CEO, and so that brought with its own sense of transition for the company. But you can really start to see people settling into their roles. Targets are out. We've got new sales comp plans in place. Our transformation program is well underway. So lots of things happening, a lot of activity, but we're very excited to see how the year plays out.

Right. So you mentioned CEO transition. So when Brian came in, I did see a lot of different personnel changes occur within the company. But maybe if you could frame out what his management style has been, how maybe his perception has changed within the company. And then how do you see his role with the transformation plan and the objectives that he's trying to achieve going forward?

Sure. I think, first and foremost, Brian focuses on accelerating growth and returning to more of a growth story. And so everything we are doing is really anchored around that and the notion that we are in a market that has tremendous potential, we are in a market where all of our peer groups have very low market penetration rates so there's lots of opportunity for us and what do we do to position ourselves to take the best advantage of those opportunities. And so first and foremost is getting the top line back. He himself is personally on the road every week meeting clients as well as employees and other folks, but really setting the tone for the whole company. And you can see that energy permeating. At the same time, he is also very focused on the notion of accountability and doing what we say we're going to do. And so that's both on the top line execution, but as importantly, on how we run the company, instilling operating discipline, getting cost out where we can and should and really making ourselves fit for growth. And so when he came onboard last spring, we launched a number of initiatives around really looking sort of across the organization at where were the opportunities, what were the market opportunities for us from a selling side, what are the cost opportunities, how do we manage that more effectively. That led to the Fit for Growth initiative that we announced at the end of October. And now we're sort of in the execution mode of all of those various work streams. I'm leading that with Brian and the rest of the executive committee. We have a number of things underway. But first and foremost is the growth story and then making sure that, at the same time, we're taking care of the operational infrastructure and discipline that we need to support that.

Right. And maybe we'll get back to Fit for Growth in just a second, but maybe while you're on kind of the outlook for 2020, how would you frame the spending environment as you're going into 2020 and you're talking to clients about how they're budgeting and where they're focused on spending, particularly relative to last year?

Yes. So I'm going to say we've seen a tremendous change this year. I mean client budgets tend to get locked down right about now. And so we're not really seeing any change in timing of that nor have we seen any significant pullback or acceleration. I think it's fairly consistent with what we saw last year. We do think there's a little bit of concern maybe in the U.K. and a little bit of concern with some of our European banking clients. And so we're certainly not expecting any significant recovery in banking as we look forward to this year, and we also talked on our call about not expecting a significant turnaround in our Healthcare business. But I think, generally speaking, it's steady. Obviously, we've seen some companies in the last few days talk about negative impacts potentially from the coronavirus. We haven't seen an impact yet on our clients and our business specifically, but that is something obviously that we'll watch over the next couple of weeks. But that's the only thing I think that I've seen a little bit of news about in the last few days post when we released our earnings.

Right. And then how would you think about the growth, margin and shareholder return set up for Cognizant in 2020? And do you think about your guidance as a relatively conservative bar? Or are there meaningful levers that could push that higher or lower as you run through the year?

So when we gave guidance and, certainly, as we think about revenue for the year, we try to give guidance that we think is prudent but achievable. We certainly don't want to miss guidance. What happened in the beginning part of last year is something we don't want to repeat, so we've certainly been thoughtful about the guidance and what we see in the marketplace. And we will continue to be prudent both as we give quarterly revenue guidance as well as the full year. And it'll be great if there's upside, but that's certainly not assumed in the guidance at this point. From a margin perspective, it's a 16% to 17% rate that we've given. There were a number of puts and takes. We talked about -- last call about the fact that in 2019 -- or in 2020, for 2019 performance, we're paying out lower than target bonus, and this year, we expect to pay out target -- at least target bonuses. So we have baked that into our assumptions. That has an impact on margins. We're making all these investments in the sales teams. That obviously has an impact on margin. And then offsetting that are the benefits that we'll get from the transformation programs and reducing our cost of delivery. So all of that gets us back into a 16% to 17% range. But I think, as I think about margin guidance for the year, first and foremost, as I said, is getting back to growth. And so for any margin dollars we do have available to us, we will continue to reinvest those for growth and really try to position ourselves well for the next few years.

Okay. And then maybe on the Fit for Growth Plan, if you could maybe frame out some of the primary objectives. I mean you have a company. It's hard to change things overnight. And sometimes, some of the changes you'll ask a company and they'll be perpetual in nature, or are always trying to make things more efficient. How much of this is short term versus long term? Is there a time horizon associated with Fit for Growth? And what are the primary, I guess, objectives that you're trying to achieve?

Sure. So as we've thought about the program, we think about it as a 2-year initiative. But to your point, there will always be a need for continuous improvement beyond that. But as I think about what we're doing right now in the next 2 years, first and foremost is getting the sales structure right, so making sure we have enough feet on the street, making sure that our sales teams have enough support in the way of sales operations folks, solution architects, service line specialists, contract attorneys, pricing people, right, and surrounding them with that whole ecosystem of people that you need to actually go out and sell services to clients and that we are thoughtful about how we go to market, where we're going to market and that we're really putting the right resources against the right opportunities where we think we have the biggest opportunities. So we've been much more thoughtful, I think, as we went into this year and as we were planning as to how we align those teams against those client opportunities. So that's a big piece for us. We've changed our comp plans for this year. So our comp plans for the sales folks have a higher variable component to them, so a little bit more risk but a lot more upside for folks who perform well. And we're also modifying those comp plans to ensure that people are selling the right services. So historically, in our comp plans, $1 of revenue was $1 of revenue. As we look into 2020 and beyond, we really are targeting folks and incenting folks to go out and sell the services that we want them to sell. So that's -- it's a big change, but I think, certainly one that will set us on the right path. At the same time, you have to make sure that you have an appropriate cost of delivery to deliver services. And I would almost bifurcate the business into 2 pieces. One is what we call sort of the heritage IT services business, and then you've got the new, the digital business. But certainly, in the heritage business, you have seen price compression over the last couple of years. And so with that, you have to make sure that you are bringing down your cost of delivery to clients so that you can compete effectively in the marketplace. And so that is a big part of the Fit for Growth program. We talked back in October about head count impact of about 10,000 to 12,000 people. About half of those, we assume will leave the company in some form or another, and the other half, we will reskill into new digital skills. But that is really intended to bring down our cost of delivery as well as some of our overhead costs as well, but to make sure that we can compete effectively in that marketplace. At the same time then, you're investing in the digital skills, so not just the new sales teams or additional sales teams but really making sure you have the right resources that can deliver services to clients with the new mandates. So that is another big piece. And then as I look at our overhead and the infrastructure to support the company, we're looking at our real estate footprint, all of our own internal systems and teams and so forth and really making sure that we've optimized those for the future.

And then maybe how did this transformation plan evolve? I mean it seems as though you're focused on some of these elements before Brian was announced. How involved was Brian in kind of taking that over the goal line? And how long was the gestation period for developing this transformation plan?

So we moved very quickly. I mean some of this is work that we had started a while ago, but I think with the announcement of the CEO transition and so forth, we've maybe lost a little bit of the focus on that. So when Brian joined last April and very quickly realized what was happening in the business, we moved very quickly in the few weeks after him joining to really stand up a bunch of new work streams and teams to go after all of this, and we really tried to leave almost no stone unturned as we looked across the company over the last summer. So we had several hundred people in the company looking at this, and we did a lot of benchmarking work and really looking at ourselves as to where we thought the biggest opportunities lay for us. That culminated in what we announced on October 30 with the Fit for Growth Program. So we tried to move very quickly from benchmarking to planning and now into execution. And each of the work streams was led by an executive committee member. And today, as we have the transformation office that is helping with execution, again, there are still executive committee members driving each piece of this.

Right. Okay. And I believe it's a $500 million to $550 million of gross cost savings over a 2-year period. How do we think about the net savings? And what factors may offset that number in terms of what you might decide to plow back into the business?

Sure. So thinking about -- for this year, for 2020, we talked about a number of about $450 million. That will grow to $550 million in 2021. And so if you think about the $450 million today and the fact that we've guided margins to 16% to 17%, so if you assume we're in the middle of that range from a guidance perspective -- we landed at about 16.6% last year. So when you factor in the fact that we are replenishing our variable comp plans back to 100% target and the investment in the salespeople as well as other investments we're making in the business this year, such as increasing our academy training programs for all the reskilling and so forth, that sort of offsets -- those things all essentially offset the $450 million of benefits that we'll get this year so it's essentially neutral. And then, obviously, as we look into 2021, we'll determine what investments we need to continue to enhance.

Okay. And then is the idea to establish a cadence of gradual improvement over time? And are you committing to a certain level of margin and revenue growth performance? And then how do you anticipate performing to those expectations over time?

So we certainly have not given long-term margin guidance yet, and we'll do so when we feel like it's appropriate and have a better sense of what we think that is. Right now, it really is about what do we need to do to get the growth back and what are the investments we need to make. Obviously, we'll see, as we get later into this year, how the productivity of the new sales hires is starting. We haven't assumed that they get to full productivity until about 7 quarters after they start. So we've given ourselves a reasonably long ramp period. But for the folks that we brought on in Q4 of last year, we should start to see some benefits as we get into the back part of this year. So that will give us a bit of a sense of how that investment is trending, and then we'll decide, obviously, accordingly how to take that.

Okay. And then it's interesting that -- it seems as though your business is evolving towards one of more exposure to digital and cloud growth from traditional outsourcing services. I think I've seen it framed out by management in a couple of different ways. But if we think about the legacy business, where your entry point into new business may have evolved from the consulting side, how might that be changing with the way that you're trying to take the business going forward?

I think it's still important to have a really strong consulting practice. And it's interesting, our long-term relationships with our clients. We have very strong client relationships and always have. We've been known for client centricity, and that's really been one of our strong points. To make the shift to digital, it's certainly helpful to have those strong client relationships. The key is can you make -- can you expand those relationships beyond just the CIO organization. So while the CIO's team plays a very critical role in a lot of the digital transformation work, a lot of the idea generation and the decisions of who to partner with and what work to do are being done beyond just the CIO organization and, oftentimes, with the CEO, COO, CMO, CFO, et cetera, and other business unit leaders. And so to make that transition in the relationship, you really do have to have very strong client partners who are fundamentally business people as well as potentially technology people, and you have to have a strong consulting front end who can help with those introductions and those relationships. So I don't think that's changed necessarily, but clearly, clients are looking for really strong business partners who can come with a point of view and with a perspective and really have a seat at the table both in -- with the client in client meetings, potentially with their board as they're thinking about some of these very important strategic decisions. And so you really do have to make sure you have the right people who can have those conversations.