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

Thanks, everyone, for joining. My name is Tien-Tsin Huang. I cover the IT services and payment sector here at JPM. So we're here to host Cognizant. Ravi Kumar, CEO, is nice enough to join us for a fireside chat. And I've gathered some good questions. Hopefully, we'll get through that, and we'll take questions from the portal, if I can just figure it out. I think I'm good now. But yes, Ravi, thank you for being here. Always grateful for your time. I think when we last spoke to you last year, you were just getting started, and it was a great conversation to hear some of your plans, many of which have come to fruition, which is great.

But maybe 16 months or so into the job, I thought -- we've had a lot of IT services companies here at the conference. You've made a lot of changes that have worked well. Can you maybe summarize some of those things that have worked well and what's still to come for Cognizant?

Sure. So thank you for the opportunity. I did come and see you last year. So 16 months on. So one of the things I did in my first year was not to front load change and back load performance. Normally, every new CEO in the first year does that. I layered change and performance together. So I kind of created performance to give me the license for change, and I made change -- created cataclysm for performance, and I kind of created a flywheel on that. So going in, I realized tech services firms have a rhythm, which Cognizant was very used to. So to get back to that rhythm, you need people who have done this for many years within the company or outside. So we got the CFO -- we got a new CFO on board. We got a new CHRO on board, which I got from internally. We got the CFO from Wipro. We got ahead of the comps business or the commercial teams. We made a lot of changes. I created more modular units. So we broke financial services into 3, and we got 1 leader from outside, and we've got 2 leaders from inside. We wanted to create new muscle. I mean, Cognizant is known for financial services and the health care ecosystem. We brought a new leader for comps, and comps is one of my industries which did very well in the last 1 year. We got somebody to run partnerships. So we made a lot of change on the commercial side. I also front-loaded commercial performance to back-end execution. So we made the changes on the commercial organization first, so that the leaks are no longer there. I mean, there were leaks in the system in some ways. So we arrested those leaks and we created traction on the front-end before we made the changes on the back-end. On the back-end, we have made significant changes in India. India is where 2/3 of my workforce is. So we've got a lot of execution bandwidth created out of India. In places where we had a strong muscle, we picked people from inside. In places where we did not have muscle, we actually picked from outside. So we made quite a bit of change. I would say a large part of that is done. There's still a little more to be done. I mean, change is always an evolving thing. And I think for the rest of the year, we'll make a few more changes, but we are in a good shape, very steady now. My attrition rates are at an all-time low. Last quarter, we ended with trailing 12 months 13.1%, which is -- I mean, I'm also carrying the load of the back-end. If I take annualized quarterly attrition, it's significantly lower. And the way to look at attrition is relative to my peers. Growth and attrition should be looked at relative to my peers. I think we're in a good spot. So a lot of change, a little bit more to do, but this has, I think, been a great run for the first 16 months. If somebody told me this is what I'm going to get at the end of the year, I would probably take it.

Yes. No, well said. No, hats off to you, especially on the attrition side and given the delivery in a good place. I know that's not an easy lift and it seems like it's in a good place. So I think last year you talked about your listening tour and what differentiates Cognizant for clients, for talent, for employees. Has that changed in your mind?

In the 25-year history of Cognizant, maybe for 20 years or maybe 18 to 20 years, Cognizant was a winning -- I mean, it was in the winners’ circle.

Definitely.

The few years before I came on board, it wasn't. But the one thing which was very common, which made Cognizant, Cognizant, and which I actually want to draw from the heritage as much as I can, is client centricity, entrepreneurial spirit -- extraordinary entrepreneurial spirit. I mean it's a very entrepreneurial firm, and it operated at the confluence of industry and technology. Cognizant was born in the late '90s when the Y2K boom was over. So it kind of started its foray into tech services using application services, application outsourcing, which needed domain expertise and technology. So Cognizant always built that strength at the confluence. I think I want to draw that strength. I think it's more relevant now than ever before, because technology is in the core of every business. So the domain expertise really plays a role. Intertwining it with technology gives it a very unique positioning in the market. So good entrepreneurial spirit, client centricity, operating at the intersection of technology and industry domain, I think are the 3 big important traits. As we went through this journey of the intersection of technology and domain, we also built a strong platform player. I mean, our health care business is probably the largest in the United States in our peer group. The entire health care ecosystem that is built on a thesis of platforms in the middle and creating a multiplier of services underneath it. I'm hoping that I could replicate that template in some of the key industries.

Good. So we'll dig in a little bit more on the business and whatnot. But I've been asking this question to all of your peers at the conference, Ravi, and you've seen a lot of different cycles. We've seen some cycles. This down cycle has been especially long. I feel like we've been fighting the demand question since the second half of 2022, and we're still seeing uneven results. Why do you think that is? I think I've heard you comment on this unwind from this pandemic boom. Of course, there are some cyclical challenges. But are there also some structural or secular issues that you think is driving some of these uneven results across the peer group?

So yes, this has been unusually long. And I don't think there will be change in 2024. At the back end of 2024, there are elections in most parts of the world, So there'll be some kind of -- I mean, I don't see situation changing positively or negatively. Hopefully, in 2025, this changes. Now unlike in the past, most times you see either periods of change or periods of uncertainty. Very few times you see periods of change and periods of uncertainty coming together. The uncertainty is because of the geopolitical situation, inflation rates, and everything else, and the change is because of the advent of AI technologies. By now, the AI revolution should have actually created a trigger on the CapEx cycles, which hasn't happened. So it's an unusual period of change and uncertainty that is kind of causing that, I would say, a standstill position. Equally, I would believe, coming out of the pandemic, there was significantly high discretionary spend. Discretionary is a large part of tech services. And almost every tech services company has the #1 industry vertical as financial services, except for Cognizant, which is health care and financial services, both are at the same size, health care is marginally bigger for us. And financial services has completely cut down the discretionary spend. A large part of it will come back. Some part of it will not come back. Over the pandemic, there was a structural shift of doing work remotely, and that has led to quite a bit of work actually going to captives. I mean, in 2023, back in India, on a base of 1.6 million employees, the captives added 200,000 employees. On a base of 3.5 million employees from tech services companies in India, they lost 150,000 employees roughly. So there is some movement of the small amount of discretionary to captives. There will be an equilibrium at some point of time, so that will stop. I mean, the split of work between captives and IT services companies had to go through a little bit of a correction and that has happened. So some of it will probably get recouped as well, because the cost of technology deployment through a captive is higher than the cost of doing it from tech services companies just because of the pyramid, the scale, and the labor cost and everything else. I do believe that the arbitrage on technology, I mean, the biggest use case for AI is applying technology on technology deployment cycles. That will kick off, that will give more productivity. As that gives more productivity, the trigger will come back to IT services. The other big shift, which I think I'm pretty sure this thesis is going to evolve, the cost of deployment of technology has to come down. The last time when technology had to be invested into enterprises back in the early '90s, when there was an information age and there was a proliferation of technologies in enterprises, the only way the pull happened then was because outsourcing was done through an offshoring wave, and that reduced the per capita cost of deploying technology. We're going to see one more wave happening. In fact, there was a second wave, I would say, when the cloud came into picture. When the cloud came into picture, the ratio of plumbing to building changed. 70% of developer work was plumbing and 30% of the work was building and innovating. That ratio flipped on its head at that time. We're going to see one more shift, one more flip of that ratio again. And that productivity change will trigger the CapEx cycles on discretionary. I mean it is necessary not because there is an advent of AI. That's the pull. The push is the higher cost of capital. I mean the higher cost of capital is almost forcing enterprises to slow down the important work. In some industries, technology is the biggest CapEx spender. In some industries, it's not. I mean, in manufacturing, you are actually competing with other priorities of manufacturers. So the cost of deployment of technology has to go down. And this time, it's not going to be on labor, it's actually going to be on technology arbitrage. And that will trigger a CapEx cycle back. I mean the clients were telling me, look, I have these 5 projects, the business case is not stacking up. If you give me a lower technology deployment cost, I think I can trigger those projects through. So we're starting to see that. So my thesis is, you're going to see a tectonic shift in technology deployment costs. This is going to be a third wave, if I may. And that will then change the way -- I mean, you could arguably say that, that will actually add more technology to enterprises. Like it did. I mean, when offshoring happened, more technology get deployed. When the cloud happened, more technology got deployed. With the advent of AI, more technology will be deployed.

No, that's a great framework that we should use in study. I'm assuming Cognizant won't be standing by waiting for that wave. And so what are you doing to position the company to catalyze growth during this period?

Yes. So in a low velocity market like this, most of the large deals -- we're doing some very good large deals. I mean, over the last 1 year, if you ask me one thing I'm very pleased about, I would actually say our large deal momentum is one of the highest. We've got a proportionately higher share of large deals in comparison to others. Most of these large deals are built on cost optimization, vendor consolidation, productivity and efficiency led. And I think we've powered some of the construct of the deals using productivity leveraged by automation and AI technologies. And it helped us to win. And over the last 12 months, we've also done analysis of our bid versus did ratios of our large deals, and we are in a pretty good spot. Now why has that happened? Very early on in March or April of last year, I made an announcement to invest on to infrastructure related to automation and AI. Now I don't think system integrators have a role to play in the innovation cycles of AI. Everybody will say this, but I don't think they have a role to play. They have a role to participate, they have a role to follow, and they have a role to invest on last mile infrastructure. What is the last mile infrastructure? The last mile infrastructure is, can I invest on platforms which can govern, orchestrate, and manage AI initiatives. Can I build infrastructure to improve the accuracy of the models? Can I build infrastructure to invest on responsible AI, because no longer safety is important, trust and equity is important, because the output is coming out of a black box? Can I actually invest on infrastructure which will optimize cost, because the cost of compute is so high? Can I actually invest on productivity studies, which will create the business case for more use case embrace? I mean, productivity is the biggest lever on AI. And the business cases are not stacking up. I mean, how many enterprises are buying end-to-end wall-to-wall Copilot. Nobody is buying. And everybody is buying small cohorts of Copilot. The reason is you need justification and a business case to do it. So what that means is, what does say, for example, a teller of a bank do today? What is the exposure score for all the tasks the teller of the bank has? What is the future tasks the bank teller does? And what does AI play a role? So invest on productivity studies which are related to human capital. So those are the areas I'm investing in. I'm realistic about what we can do. I mean, the billions of dollars being invested on the innovation cycles, I don't think we have a big role to play there. We have a role to play to take the raw power of AI to enterprise-grade AI and to make it embrace worthy. Even in spite of that, enterprises are not embracing it. I have 500 prototypes running on AI. Very few are production grade. So that journey, that cycle is going to take us longer. So we have a lot of work to do, heavy lift to do in the last mile, and that's where I'm investing on.

I like that construct as well. So back to the large deals that you've won. You said it's been a consolidation, it's a lot of cost optimization type of work. Is there something new to be learned on the margin profile of such deal and pricing? And of course, getting closer to the client is always a win, as they get ready to transit to go after the last mile you described. But just tell us a little bit more about the piece.

So if you have noticed, in the last 2 quarters, we made sure that most of those large deals we are winning, we are actually announcing it in the market as well. So one of the recent ones we did was Telstra, which was an extraordinary win in Asia Pacific. In most of these deals, when you're doing a cost takeout and a vendor consolidation, the first and foremost is you need to be a stable player. I mean, if you're not a stable player, you will get consolidated out, leave alone you winning business. So we were on the losing side before. We are now on the winning side. Because we are a stable player, we have the right to win. I mean, I ask all my teams, if you have the right to win, then we'll go and fight it out. If you don't have the right to win, there's no chance. We think we have invested heavily on this productivity infrastructure, which is allowing us to do this at a highly optimized, very efficient cost model. So once you have a stable leadership and a stable team, and you're doing your piece well, you have the license and the right to ask for more things. So those consolidation opportunities, we are now on the winning side, because the productivity benefits we're willing to share with our clients is compelling enough for them to provide it. There are some swim lanes where we otherwise had a strong position, like health care. I mean, health care, named the payer of the United States, we are probably having the #1, #2 or #3 wallet share. So we have the license there to go back and say we can actually do more cost productivity and vendor consolidation. The reason why we were not doing it before, we were not playing large deals. Second, we were not stable enough. If you're not stable enough, you can't go and ask for others' business. Your business is up for stake. So I think we are in a good spot to win. This is also the CEO's agenda. I anchor all the large deals in the company. And this is right from my office. We have unified the firm. And once you unify the firm, it's very hard to beat Cognizant. Wherever we have not put the might of the company behind, we have lost. Wherever we've put the might of the company behind, I think this is an extraordinary franchise. So the chance of losing is lower. So we've kind of made that happen most times, and that has worked for us. I mean, there are places where we are not participating. For example, my exposure in some of the industries like energy, utilities is not so high. My exposure outside the United States is not so high. I mean, we only do 25% of our business outside the United States. In fact, if you look at my peer group, a large number of them do between 35% to 40% outside the U.S. And the markets which are growing, for most of them, it's actually international markets outside the U.S. So I have gaps, which I have to fix either through organically or inorganically.

Can it be done organically, Ravi?