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

Good morning again. Matt O'Neill, payments and IT service analyst at Goldman here. Very pleased to have Brian Humphries, CEO of Cognizant, joining us this morning.

Brian, I was hoping we could jump right in. It's been about 2 years since joining Cognizant. Back in 2019, you first announced the transformation office and since, have been executing on the Fit for Growth initiatives, as you guys called it. Could you just take a step back, I know we just kind of wrapped the year, and talk about kind of the accomplishments against some of those ends and where we're set up for now?

Yes, of course. Happy to be here as well. So yes, to your point, really probably in May 2019, we launched what we call the transformation office. It touched upon many things: the strategy, commercial acceleration, delivery optimization. And then there were a series of work streams around things like culture, structure and Fit for Growth, which was perhaps, euphemistically, people may have thought about that as a restructuring element only, but it was also about enabling Cognizant to go from being a $17 billion company to a $30 billion annual revenue type company and making sure we had digitized our processes internally to allow us to scale. Look, we've executed well against it. I think we've done a good job, all things considered, particularly against the backdrop of COVID and a ransomware attack in the core of the year. What we've done, clarified our strategy. We adjusted our portfolio accordingly, both mergers and acquisitions, and we spend meaningfully against digital acceleration. But also, we exited certain categories such as content moderation that just was not strategic relative to the direction we wanted to take the company forward. As a knowledge-based business, employee engagement is really essential. So we spent a great deal of time around our purpose and our vision and our values, and we actually ended the year with employee engagement scores at multiyear highs, which was something I'm particularly proud about. We executed the restructuring program. That allowed us to take out costs. And in some regards, what I tried to achieve when I joined was to tap back into the Cognizant culture, which is a growth culture, but we had to restart the engine. So we took those savings and ultimately started reinvesting that back into our future. And the good news is that bookings, the leading indicator of revenue growth, grew in mid-teens in the year. So -- and I would also add, by the way, our backlog built materially through the course of the year every single month. So we're entering the new year with a great deal of confidence, clarity on many levels, including, in my opinion, a much stronger portfolio, both through the acquisitions and the exits. And I would include in that, by the way, the delivery organization. Our portfolio of accounts is strong. And you know in the last quarter, we announced an intent to exit a certain FSI, Financial Services contract in Europe. I think we'll be better for it, and our brand will be better for it and the client will be better for it. We also have better momentum on bookings. That gives us confidence, as I suggested earlier, a better cost structure, more variablized, allows us to invest in growth. And in some regards, what is important, I think, for investors as well, we have more flexibility and control on our own destiny this year, all other things considered, because more of our cost structure is actually allocated away from fixed costs and much more towards investment-type criteria. And that comes, of course, on top of a refined capital allocation priority. So that's where I view the progress we've made.

No, very helpful overview. You mentioned the anticipated financial service engagement exit. I know this came up to some degree on the recent earnings call. But can we just kind of go through again how you assess the rest of the portfolio and the kind of go-forward confidence in this one being that one-off idiosyncratic dynamic that it was, maybe explaining implicitly kind of what made it different or unique as a result?

Yes. No, of course. Look, it was pretty frustrating for me because outside of this onetime write-down, which impacted company growth by 2.5 points, it impacted operating margin by 3 points and EPS by $0.25. Outside of this, this was a beat-and-raise quarter. And so we really did this, I think, for the right reasons. And I think the brand and our customer relationship will be stronger for it. But back to your question, we have what we call a delivery excellence organization, and that allows us to stay behind a sophisticated, what I would call, set of delivery methods. For want of a better word, think of this as principles, programs, governance, tools, methodologies. And as you can imagine, as a company of our size, we have about 20,000 projects or programs underway in our delivery organization at any one time. Now these projects and programs are constantly reviewed and mapped. And it's fair to say a company of our size as well will always have projects. The vast majority are green, but there are some projects that are amber, some projects that are red. And these products are monitored. They hit my radar. I personally get involved with client dialogue as needed, subject to where we are with these projects. So I know exactly where we've stood. The project we're talking about that we've decided to exit in mutual agreement with the client, albeit at an LOI stage at this stage, was solution before I joined the company in late 2018, and it was maybe on the extremity in terms of ambition, not the business as usual. We're maintaining business as usual as we speak. We're billing against that, delivering against it. But the transformation was much more ambitious and more unique in nature. As I look at the rest of the portfolio, no lawyer will ever allow a CEO to say in an earnings transcript, "This was a onetime impact" in case anything ever happened in the years down the line. There'd be class action and lawsuits. But I feel extremely confident, Matt, about our client portfolio. I feel confident about the enhanced rigor we have in our deal review and our solutioning processes, many changes of which we've made in the last year. And that comes on the back of some of the people we brought into the company in the last year, a new head of global delivery; a new chief admin officer who's in charge of, amongst other things, pricing as well as contract management; and a new CFO, each with their own experience. And now we have a much more rigorous approach to how we think about deal pursuits, deal solutioning and indeed pricing.

Got it. Very helpful. Kind of going back to the transformation. On the earnings call, I think when asked about it, you and Jan indicated that you're kind of in the middle of the transformation. And I think when you think about middle, there's a little linear progression of, "Okay, we've got 10 things we want to do. We've done 5," right? But I think when you think about it from the company's performance perspective, it could be interpreted as an inflection point, right, where a lot of the work has been done, a lot of the building blocks have been put into place for where you see the business going and then you can start to think about the reacceleration coming out of that kind of middle of the transformation, if you will. Is that -- do you kind of agree with that thought process? And what's kind of left on the agenda, if you will, in the back half of the transformation yet to come?

Yes. So a very good question actually. And as I think about this, I call it a multiyear project to reposition the company. The core of the company is extremely healthy. It's just we are shifting some focus into certain areas. And look, I will say that as much as I feel we're in the middle of a transformation -- and I view that as a positive thing because the more progress we can make, it will show up in the numbers. And I've got plenty of things to go work on, which will ultimately free up more investment capacity or indeed more margins over time. But the good news is even though we're in the middle of things, some of the heavier lifting of the transformation is already behind us. I mean that first 18 months, 2 years during which we also had COVID, during which we also had a ransomware attack, but we had meaningful leadership changes. And I pulled the trigger on a restructuring program with a view to freeing up investment dollars that I can reinvest back into growth in the future. And the fruit of that work is now more and more evident in the bookings strength we had in the course of 2020. The importance of getting revenue moving again is, of course, that we get gross margin dollars. And those gross margin dollars then start covering other investments that we want to make. At which stage, it becomes a self-funding P&L. And that's what I call the P&L starts singing, if you will, for want of a better word. So I think we've managed the transformation to date well, all things considered. Where are we now? And what do we still have to do? Put simply, we have to execute against our strategy. That involves repositioning the brand, making sure people think of us as holistically and with the stature we desire; globalizing the company, which is a huge opportunity for us. 75% of Cognizant's revenue comes from the United States. If you go into Western Europe, to take one example, in very many of those countries, we have 4 or 5 clients that constitute the vast majority of our revenue. So we are massively underpenetrated, and we have so much more opportunity in those markets. Third priority around accelerating digital, it's important because it makes us more intimate with clients. It gets us more involved in the spend of clients around transformation and innovation. And we've made good progress there in the last year, but of course, more to do. And the fourth piece of our strategy is really around increasing our relevance to clients, which moves well beyond being a provider of bodies in a build or operate phase and much more into that helping clients ultimately engineer modern businesses, helping them look around the corner, having a point of view, being much more proactive with technology consulting as opposed to being humble and waiting for somebody to solicit or help in the form of bodies. And I think if we execute against that strategy, we're in a great position to drive shareholder value creation in the years ahead. But I will stress that our ambition is to drive shareholder value creation over the medium and long term and drive sustainable earnings growth. And that ultimately means we're still investing in the business today. There are certain things that will be ongoing and certain things that are, let's say, less ongoing. But I think about talent, I think about digital investments, I think about commercial hiring, branding, digitizing the company. And of course, we're doing some more work around, let's say, making our IT and security systems more robust. We spent a lot of money on that in the last year. So look, we're executing our playbook. I think we're on track. We're doing well, but there's more work to be done.

Yes. No, that makes sense. One of the areas we spent time on in our conversations this prior was around kind of the decisive changes you've made at kind of the top of the house, right? The direct reports to you and their direct reports, as I understood, there's been a lot of changes made as well as kind of a new comp structure to incentivize and motivate the teams kind of behind that. Can you talk about that strategy and that evolution, kind of when you inherited Cognizant to how it's oriented today? Because, at the end of the day, it's a human capital business. It's the most important asset of the firm. And you've really kind of taken a step forward as I understood it.

Look, it was hard because it's a proud company. I'm very proud to be the CEO of Cognizant on the back of 25 years of success, and what Frank has achieved prior to my arrival was nothing short of remarkable. But I think the company hit an inflection point in the last number of years on the back of an activist investor, there was rumored CEO transitions. And then what was happening around us was a major focus on visa dependency reduction in North America, which I think we fell behind on; and then a meaningful shift around this from a technological point of view, the so-called shift to digital, where Cognizant wasn't particularly participating as much and we were somewhat relegated maybe from a brand point of view to be more viewed to be in the build or operate phase and not particularly involved in the more aggressive part of selling beyond the CIO or CTO organization across the broader C-suite who, of course, are sponsoring much more of this digital spend. And so it struck me that we had to do a lot. We had to scale internationally. We had to ready ourselves for -- to catch up in digital, if you will. Two years ago, we were a niche player in cloud. Last year, we moved to challenger. This year, we moved to leader. All of that required us to fundamentally think about the talent we have, how they were motivated, how they were engaged, if they were ready to -- as a client-facing team to sell beyond the CIO or CTO and to have the disposition and the gravitas to stand in front of the C-suite more broadly. So we did a lot in that regard. And frankly, my great hope for the future, to be very honest, is so much more of the talent promotions we make will actually be internal. But that requires us to have had much more sophistication from a talent management point of view than we had when I arrived. It was one of my things that surprised me, to be very honest. As a knowledge-based business, we weren't quite as rigorous in that regard as I would have expected. So I think now we have a world-class team. It's a team that's fully unified. We see this as a hugely attractive market. It's a growth market. And we're getting after the opportunity as a leadership team. Now below that then, to your point, client-facing teams, more often than not, they were on 85% or 90% fixed compensation and only 10% or 15% variable. And even then, it wasn't always applied rigorously. So even if people missed their numbers, they still got target earnings, et cetera. I believe in a high-performance culture that is inclusive from a diversity and inclusion point of view, but also it's built around a culture of meritocracy. And I think you always have to try to attract the best people to the company, try to reward them in a differentiated manner. Now that, of course, pleases people who like meritocracy. It can sometimes be a little bit of a stone in the shoe for those who don't. But in some regard, that's the direction we're going with the company. It's been a big success this year. We introduced bookings as part of our compensation program. And as you know, we funded a lot of extra coverage in the last year. Through the course of the year, we've added almost 500 commercially-oriented head count now. But also, we motivated people to actually go and get new extensions, renewals or indeed new logos, and that really gives us a great opportunity to land and expand. We still have a huge opportunity in our existing book of business. And I will focus on that because there's a lot of cross-sell capability there. But simultaneously, particularly internationally, we have so under-penetrated these markets that there are Global 2000 clients that we want to get into. And I'm pleased to say, last year, we broke into 40. And those 40 Global 2000 accounts then give us rich opportunity to upsell and cross-sell the portfolio.

That makes a lot of sense. Another thing I was hoping we could kind of address is your vision for the industry. I think in our first conversation, you said something about the industry that really resonated with me and helps me kind of frame it in a slightly different way, and you described it as a cottage industry. And of course, you are correct. I went and looked at all the market share stats. And even as one of the largest players, there's no really nobody with more than mid-single-digits market share. And I think as we envision the industry being increasingly focused around all things digital, that likely will drive virtues of scale at an increasing level. The people that can collectively deliver the solutions that the top 1,000, 2,000 companies globally need. So how do you sort of envision that cottage industry evolving from where it is today and becoming presumably a bigger part of that mix over time?

Well, look, you're absolutely right. It is a cottage industry, but this is an incredible market more generally. First of all, it's huge. We think the addressable market opportunity is in excess of $1.5 billion. The second thing I'd point out, it's a growing market. Even today, mainstream industry analysts, whether it's Forrester, Gartner, Everest, IDC or otherwise, are all thinking market growth rate will be in the range of 2% to 6% for 2021. But thirdly, unlike a software industry or a hardware industry where perhaps 2 or 3 logos can actually dominate, services is actually a cottage industry. No company has ever had, in the history of the services industry at a global level, more than a few points of share. And if you think about that much more holistically, nor will they ever have more than points of share because it's the nature of a knowledge-based business. We guided 2021 revenue to $17.6 billion to $18.1 billion. We'll have about 300,000 employees. So even if we were twice the size of where we are today, we'd still only have points of share and we'll be over 0.5 million employees. And it just shows that the law of numbers catches up within the services business. At some stage then, it goes back to choice points. Where do you focus? We have a very strong focus on North America. That is our heritage. But of course, we have a big focus now internationally, which is less than 25% of our business. So we are under-penetrated. I expect, candidly, given the team we built in international markets now, exponential growth in the years ahead, and that will be funded organically and indeed inorganically. I think also customer segmentation. We've clearly focused ourselves towards the Global 2000 accounts, and I referenced that 40 that we broke into in the last year. And even those that we already have, we need to do a much better job, frankly, cross-selling and upselling in the portfolio, which will require us, by the way, to make some trade-offs on what I would call long-tail accounts that we've been into historically. And then more, perhaps, meaningfully for us, digital. It's a higher-growth category. And we've increased our digital mix in the last 12 months by 5 points of our revenue mix, and we spent $1.5 billion in mergers and acquisitions in digital in the last 12 months or so as well. I think there's a true opportunity for Cognizant to show up and really get on the attack in digital. If I go back almost 2 years ago when I joined, in the early week or 2 when I was meeting clients, a lot of clients saw us in build or operate. But when I talked to them about the digital portfolio, in many cases, they did not even know that Cognizant had a cloud capability or an interactive capability or a product engineering capability. And so I've spent a great deal of time really trying to hone in on that in the last 18 months to 2 years because I think there's a tremendous opportunity at the intersection point of cloud and digital. And so I've actually collapsed the organization internally in recent months to really get at that intersection point. All of that ultimately, I think, is good news for us. Growth acceleration ultimately, and we're currently investing to get at that growth. And the bookings momentum of last year is a strong leading indicator of that. Our guidance for 2021 sees us accelerate revenue growth to 5.5% to 8.5% reported revenue growth, plus showing some margin expansion despite the fact we're investing hundreds of millions of dollars back into the business.

No, that's helpful. And you started touching on exactly where I was hoping to go next, which is around what will help presumably accelerate that consolidation, which is M&A, right? So like you said, you've done $1.5 billion since just 2020. You've been repatriating cash from India to sort of facilitate presumably the continuation of what is undoubtedly a pipeline of deals that you probably see going forward. Can we talk about kind of some of the deals we've seen? Magenic was one that was really interesting to me on the engineering front and thinking about bringing that expertise to the client. Are we thinking about that the right way, about kind of getting more involved with the clients at the development side of the equation and becoming more of that trusted adviser? Maybe you could discuss how that's going to unfold within the broader Cognizant.

Look, Matt, you're spot on. We have a corporate strategy that's ultimately built around repositioning the brand, globalizing the company, accelerating digital and increasing our relevance to clients. And if I think about the latter 2, having a really strong portfolio where we have technology competencies and a stronger point of view and a stronger set of capabilities coming to bear will only make us much more relevant to clients. First of all, I always think about M&A simply as it goes back to our corporate strategy. It's a means to an end. It is not the strategy. But your portfolio needs to be adjusted in light of your corporate strategy. And that, in some form, can take -- can mean divestitures or deemphasizing businesses as we did with the exit of content moderation. But it will also mean areas where you need to buttress your strengths or build more capabilities. And if you think about what I've really been focused on, particularly in the last year because the first year, I didn't do so much M&A. I really wanted to understand the company, refine the strategy, get the leadership team in place because you have to trust people then to get the value from the acquisitions. But we started pushing M&A along the lines maybe of technological competencies or that dimension, a geographic dimension, a technology consulting or advisory capability dimension. And that's where we ultimately spend our money. Our M&A spend is 100% aligned to our strategy. If I focus in on the accelerating digital component of our strategy, we spent $1.5 billion behind cloud acquisitions, digital engineering, IoT, AI, ML, analytics. And along those lines of competency, cloud, we did 2 Microsoft acquisitions. We've set up a Microsoft business group. We did a series of packaged application capabilities. Think of Workday, where we stood up our practice for the first time in our history. We did 3 Salesforce Platinum partner acquisitions, and most recently, we acquired Linium, which was a ServiceNow partner. And that's how I see the world evolving. We're complementing Oracle and SAP of the world with the Salesforce, with the Workdays, with the ServiceNows of the world. The second major area that we focused on was AI and analytics. In January, we announced the acquisition of Servian, which is actually at the intersection point of a technological competency as well as a geographic priority market, ANZ. Earlier -- a few months earlier, probably in November, we announced the acquisition of Inawisdom, again, an AWS platinum partner around AI, ML in the U.K., another priority country for us. And then to your point, and perhaps, Matt -- and I think you've written about this, but I think it's one of the great secrets of Cognizant. We are now one of the largest digital engineering companies in the world, and you will see us continue to build out those capabilities. We acquired Tin Roof in the fall. Magenic is a company we announced the acquisition of in January. And this sits on a very strong portfolio that was built over recent years, including the 2018 acquisition of Softvision before I came. But at the core, we are an applications company and a data company. And so as companies go through application modernization, we have tremendous capability now from app modernization through to software cloud-native application development more -- as you think about software product engineering more holistically. So I'm very excited about those possibilities for us.

Got it. One area I was -- I wanted to sort of circle back on, sort of moving down the corporate structure on the employee side. The pandemic has obviously accelerated a lot of demand for digital, but it's also resulted, on the flip side of that equation, in putting a lot of competitive demands on the labor market for this sort of scarce resource of talent. So how has that kind of impacted the hiring strategy? What does that sort of portend for the business as you're balancing repositioning the brand, attracting the right people to Cognizant and meeting clients in the middle with the solutions and people who can actually execute on them?