Cognizant Technology Solutions Corporation (CTSH) Earnings Call Transcript & Summary
May 30, 2024
Earnings Call Speaker Segments
Bryan Bergin
analystIt's day 2 of TD Cowen TMT Conference. Thanks all for joining us. My name is Bryan Bergin. I cover IT services, fintech and payments at TD Cowen. Very pleased to have Cognizant CFO, Jatin Dalal, with us. Jatin, thank you for your time today.
Jatin Dalal
executiveThank you very much for having me here. Thank you.
Bryan Bergin
analystWe're going to go through a fireside chat. We'll open up for questions for the audience at the end. But to start, Jatin, I think it would be helpful kind of the intro and the background question first, just given you formally became Cognizant CFO earlier this year after more than 21 years at Wipro. And certainly, that decision you made here to jump from Wipro to Cognizant, I wanted to start there. And then what did you see in the opportunity that led to the change?
Jatin Dalal
executiveSure. So I've been around in the industry for more than 2 decades, and I have always had a very positive view of Cognizant outside in. We always knew that they were a competitor who you deeply respect, who were -- I mean, the company was growing much faster than everybody else for nearly 15 of those 20 years. They really set and took some bold calls like TriZetto 10 years back. So that really was a company which was a fascinating company from outside. And when I saw this opportunity to be part of the story, to be part of what happens at the company and how we perform in the market for next decade or so, I thought it was a fabulous opportunity for me to be part of it.
Bryan Bergin
analystOkay. And you did see a couple -- from your seat at Wipro before, you did see a couple of management teams come through Cognizant over the last several years. Did your perspective change as you kind of competed day-to-day with them?
Jatin Dalal
executiveYes. I think for every company what matters really is how you are competing and what you're bringing to the table for competing on that? And I thought at least I could have a voice in that as I joined as a part of the management team, because this was a fabulous engine which could run at a particular speed. That was my outside in perspective. And of course, there are certain changes which happened in the company, but I don't think that changed anything about the company. It was a particular strategy adopted at that point in time, which was probably appropriate at that point in time.
Bryan Bergin
analystOkay. And now that you've been in the seat of CFO Cognizant for going on 2 to 3 quarters now, what's the initial impressions? What are the early learnings from the inside?
Jatin Dalal
executiveSo it's a fabulous feeling to be here after first 6 months or so. There are 2 or 3 things I do believe are the core strengths of Cognizant, which even through last few years of change in strategies has not changed. And one is that the whole organization is built on a thesis of growth. Everybody wants to grow. And I think that's really strong positive DNA that Ravi and I can build on. Second is there is a whole strength of employees who have been around for longest amount of period of time. I call them citizen employees. Who is a citizen? Citizen is somebody who will take bullets for the country without thinking much about it, right? So we have a core of employees who will want Cognizant to perform well, win in the market, and be the best in the industry. And I think these are the 2 core strengths. We can build everything else around it. But the will to win in the market, and then eagerness to do everything around that will is something that I think is our core strength.
Bryan Bergin
analystOkay, yes, a key foundation for future.
Jatin Dalal
executiveYes.
Bryan Bergin
analystSo let's talk about where you've been spending the most time here and the early priorities. So we understand, obviously, Ravi first prioritized stabilizing the workforce, got attrition down and under control, as well as developed that large deal and that commercial muscle that wasn't there before. But in your seat as CFO, talk about your top priorities here.
Jatin Dalal
executiveSo I will say, predominantly, one is just making sure that the market momentum gets converted into revenue momentum. And the market momentum conversion to revenue momentum is often stated simply, but it's very difficult to achieve in an IT services company, because we have huge number of SKUs, skill set, experience, locations, et cetera, and the demand. And quality in our business is not high-quality engineer, but a high-quality engineer when customer needs him or her at that point in time. So how do you operationalize the customer and employees connect in a way. If we can get these 2 equations -- I mean, if we can get these 2 running in rhythm, everything else falls in place in an IT services company. So I think the first part that I have been really focused on is to just really work around how do we internally mobilize ourselves around the wins that we have in the market and how quickly we go behind it and execute it. And I'm very happy with the way we have progressed in the last 6 months, just being very, very diligent and agile around everything that we are seeing in the market and how we respond to it. So that's part 1. Part 2 is really making sure that we are doing all of this while keeping 2 things in mind that, one, we remain very competitive. You can do all of this by putting more stock or more inventory of skill sets and be more agile. But that's not what would eventually be beneficial for shareholders. You have to remain very, very agile also on the cost side, saying, how do I remain agile on response, but I don't create a huge inventory of capacity to serve that customer need. So cost is another big angle. And within the cost, cost of revenue is one big thing. Second is NextGen, which is our big getting fit on nonbillable cost standpoint initiative. So these are the things that we have been wrestling on the cost side as a part 2.
Bryan Bergin
analystOkay. Let's dig into NextGen then on restructuring efforts. Can you give us a sense on what's the latest progress there? Where are you in the scope of that program? And certainly, there's always operational tweaks in the business. So you can't say ever it's done, but are the biggest changes largely complete?
Jatin Dalal
executiveI think we have made substantive progress in 2023. I wasn't here, but I must compliment the team which was here, which executed it very well. We have our priorities set for 2024, and as you know, of the $300 million of total charge, we took approximately $230 million in 2023. We'll take another $70 million in this year. And we are progressing well. I wouldn't say we are largely done. I think the execution continues to remain for another few months before we can say it's largely done. And that's how it was planned. So there is no change on that. So I'm quite happy with the way we are progressing and we are executing on NextGen.
Bryan Bergin
analystOkay. As far as the $230 million that was done and then the balance here this year, can you just remind us what areas of the organization is that hitting? What initiatives are you leaning into on that $300 million total?
Jatin Dalal
executiveSo that is essentially nondelivery costs. Those are the costs associated with corporate functions. Those are the costs associated with facilities. Those are the costs associated with anything that is noncritical for service delivery to our customer.
Bryan Bergin
analystOkay. So from an aspect of getting lean, the operational flexibility, and just becoming more nimble.
Jatin Dalal
executiveNimble. That's right.
Bryan Bergin
analystOkay. Let's pivot to demand. So certainly, it's been a volatile backdrop in services over the last, feels like, 18-plus months now. But talk about what you've seen in recent months and how it's progressing. Can you maybe speak to any demand indicators such as pipeline, replenishment, bookings, the pace of revenue conversion, things like that?
Jatin Dalal
executiveSure. So demand is what it is. Demand environment has not changed. It remains tough. Discretionary demand is certainly down, continues to remain in the negative growth zone. So it's shrinking year-on-year. Good part about the equation is that there are more large deals in offering. We are executing on those large deals. We are winning, I think, a little more than our fair share on large deals. Customers want to bet again on Cognizant. And we are executing the ones that we have won quite well, so that it becomes a sort of point of reference for our new deals. So overall demand environment remains tough. The shrinkage on smaller size deals is, in some form, replaced by the large size deals that we are doing. But essentially, that means that the book of business is far longer term now than what it was in, let's say, 2022, where predominant portion of demand was more short-term demand.
Bryan Bergin
analystOkay. As you did affirm the outlook for fiscal '24 in the most recent print, talk about what you've built into the assumptions underlying that forecast?
Jatin Dalal
executiveSo I think what we have assumed is that there is a certain amount of variables that could play out, one or more of those. As you know, our guidance is minus 2% to plus 2%. So the midpoint is still a flat year-on-year outlook. And to get there, we'll have some support from the rest of M&A that we have spoken about. We have spoken about 100 basis points, and we have executed on 60-70. So we have some runway there. There would be some large deals, which will fructify. There would be some amount of spend somewhere on discretionary side that we hope will come back. Now not all of this would add up to the number, but some of this converting would help us reach to our midpoint of the guidance is what our sort of hypothesis is.
Bryan Bergin
analystOkay. A common question we get is this downturn in the broader industry as far as the demand drop does feel more elongated than it has historically. You've been in the industry 2 decades plus. So you've seen different cycles here. So I'd appreciate your perspective on kind of what factors do you think are contributing to this slower recovery?
Jatin Dalal
executiveI mean, it's a fascinating question, because this industry as such is a new industry. I mean, if you take away the likes of EDS before, let's say, early 2000, this is a new industry. And the new industry has only seen, in last 25 years, only one type of slowdown, which is a big ramp-down crisis, 2 bad quarters, and then a sharp recovery as a [ VBAC ]. Almost always, the interest rates have aided the recovery by a sharp cut at that point in time. And the cause of the crisis was never interest rates. Now there's a relatively new learning zone for the industry where the cause of this slow noncrisis, but very difficult period is interest rates. And we don't know how long this will go on and at what point in time sort of the tide will turn. My own understanding of the industry is that there is only so much discretionary you can hold back for a point in time. At some point in time, some regulatory changes which you thought were needed only in beginning of 2025 is now here in beginning of 2025 (sic) [ 2024 ]. So you will have to now make those changes, or some amount of change, some amount of upgrade would be necessary. So I think we are stretching that tolerance zone for slowdown. And at some point in time, it has to give into some amount of demand. But I mean, all of us are in that learning zone, how this slowdown turns out to be.
Bryan Bergin
analystOkay. We've heard that too as far as whether it's forced by regulatory change or disruptors in your industry, right, competitors coming in at a certain point, you can't hold the purse strings.
Jatin Dalal
executiveAbsolutely.
Bryan Bergin
analystYes. Let's talk just about the discretionary market. So it certainly has been blamed for a lot of the predominant amount of the spending pressure in the group, and it would seem like the discretionary makes up the majority of some tech services budget. So how do you quantify or categorize discretionary? And does it vary as you go across industries?
Jatin Dalal
executiveSo yes, I mean, every industry has its own way of looking at discretionary, but what we look at internally, and this is probably a more financial way of looking at it, is the velocity and volume of smaller orders less than $5 million, less than $10 million? Because they come with the propensity of getting consumed very quickly in year and converting into in year revenues. And that is for us -- I mean, internally, that's what we measure on a daily basis how the discretionary smaller orders are coming through. And they have been quite muted in terms of their outlook of late, as I described before.
Bryan Bergin
analystOkay. Okay. When discretionary does loosen, what areas of the service portfolio do you anticipate will pick up first?
Jatin Dalal
executiveSo I mean, it's a difficult view to make. However, I can tell you we will know before it happens. I mean, every morning we get on a call and we see where do we see the demand little bit up, little bit better. As of this morning, I can tell you, it is SAP S4 HANA, it is some skills in cloud, it is some skills in digital engineering. But that is still a very small stream. I mean, it's nowhere close to a river. But we'll watch it closely every morning, and we see that portfolio expand. I mean, the really slow ones are application development, maintenance, quality engineering, and other things, where we are really struggling to find any life. So I think as we continue to watch the streams, then we'll know where we are seeing the momentum.
Bryan Bergin
analystOkay. Is there an aspect of this around Gen AI as far as that causing confusion or causing some level of delayed decision-making or any other pressure within services pockets as a result of just all of the focus in that area?
Jatin Dalal
executiveI would say no. I think GenAI would -- I mean, every time the industry needs a new momentum leader to ride through the next 4 or 5 years. If you see between 2008 and 2011, it was infrastructure services. Then it was digital, then it was cloud. I do believe that GenAI is that momentum leader for the industry for the next 4 or 5 years. So if at all, I think, GenAI could be the sort of a trigger at some point to get the discretionary going.
Bryan Bergin
analystOkay. As we move past the proof of concepts, the science projects, so to speak, right, at enterprise scale.
Jatin Dalal
executiveYes.
Bryan Bergin
analystOkay. As far as structural demand and as you think about the industry from a growth rate standpoint, what do you believe normalized growth for the group ultimately looks like?
Jatin Dalal
executiveIt's a great question. But quite frankly, I don't know where the answer is. I mean, before COVID, we used to give some number, and COVID created a disruption. And I don't think we are out of that phase where we could say that there is a stable growth environment looks like this. And even internally, therefore, what we are thinking is that let's not too much worry about that and let us worry about we operate every day in the market and can we win in that market. So even if the growth is slow, can we have a disproportionate market share gain in a slow growth environment? And that's where we are working towards.
Bryan Bergin
analystOkay. That's fair. And you got obviously a lot of company-specific factors going on. So one of those large deal commercial muscle that you've been building. Let's talk about kind of the perspective there and how that is progressing? And you certainly picked up pace there. Is there a way to parse the success you've had because of the initiatives you've laid in versus the industry in general that seems like it has had a shift toward more large deals?
Jatin Dalal
executiveI think it's both, because post-COVID, industry was trying to get a lot of -- our customers were trying to get a lot done in a very short amount of time, and they didn't have time or wherewithal to construct large deal and hand out to vendors. So that change in '23 when -- so '22 was very different, '21 was very different. '23, you started seeing the packaging of large deals, because it was inefficient for customers to hand out large pieces of work in small quantums. But I think for Cognizant what changed really was that there was a clear tone at the top that we want to participate in large deals. We have always been leaders in large deals. If you go back 2008 to 2017, I think we were winning a disproportionate share of large deals. So company always had that muscle. So it was a reorientation of sales mindset saying we have to participate and we have to participate our fair share and maybe a little higher than fair share. And therefore, we created a large deals team, we created a delivery capability behind it, we created sort of ongoing monitoring mechanisms around it, and so on and so forth. We got people who executed on large deals, because winning large deals is 40% or 30% of challenge, 60%, 70% of the challenge is executing on large deals and how do we execute on those. So I think it's also company-specific where we have created a resolve and resources both tied up around large deals.
Bryan Bergin
analystOkay. As you think about the deals you've won over the last 12 months plus, are there particular areas you've had good success like service type?
Jatin Dalal
executiveI would say we are operating at a good rhythm of execution across the deals that we have won over the last 5 or 6 quarters. I wouldn't say there is any specific area where we are more successful, or we are less successful conversely. There is a ratio of good execution in the industry about large deals, because it's never 100%. And I think we are operating around that good execution number. And where there are changes -- typically what happens is sometimes you construct a large deal with certain assumptions around business priorities and those business priorities change, and you have to then refit the large deal assumptions around the new business priorities of the customer. In those cases, you go slower than what you had originally anticipated. And that is still part of our portfolio as it would be part of anybody else's portfolio.
Bryan Bergin
analystWhat are kind of the important considerations that investors need to be mindful of when they look at the bookings trends and the things like that as the large deals that you have been landing. Just talk about the bookings, the large deal dynamics, as we think about revenue conversion over time.
Jatin Dalal
executiveYes. So I think this is the most difficult to explain externally mathematical equation in my mind for the industry, not just for Cognizant, because there is one factor of variables, which is not visible externally, which is the noncontinuation of existing business for the companies. So almost always the assumption is that there is a stable base and the large deals are adding on top of it, so that there is a certain amount of revenue growth which must be expected. However, in current times, there is a ramp down in existing business, which is not sudden, which is not like, by Monday, I want to ramp down 300 people kind of ramp down. But it is the lack of discretionary spend that we are talking about, which means that there is a volume which is reducing, which is only getting replenished by the large deals that we are winning. So large deals right now is really not nice to have. It is the existential requirement of a large company to make sure that the revenue line remains stable, because it's only replacing the ramp downs. So to that extent, it's a difficult equation where you see a big bookings growth, but you don't reflect that immediately on the revenue growth, because the revenue has another negative factor, which is not factored in the booking growth number.
Bryan Bergin
analystYes. We kind of call it the leaky bucket.
Jatin Dalal
executiveYes, absolutely. And times like that -- I mean, again, there is a threshold with which industry operates on a leaky bucket. That leaky bucket was almost nonexistent in second half of '21 and '22. Therefore, you saw 15%, 17%, 18%, 20% growth of the industry, of larger players. Right now, that number, I think, is much larger than what we have seen over the last 5 years.
Bryan Bergin
analystOkay. And at the same time, too, naturally with that much less shorter duration deals, your average duration in your base of business is extended.
Jatin Dalal
executiveYes, absolutely.
Bryan Bergin
analystOkay. Let's talk about margins now. So where do you see the greatest opportunity for expansion?
Jatin Dalal
executiveSo for us, the greatest opportunity lies in executing well on cost of revenue side, on gross margin side. NextGen is more being competitive and fit, too, and agile and nimble enough to respond to the market requirements. But clearly, the opportunity is greater on gross margin side. Utilization is one big lever, automation is another big lever. On-site offshore mix is a very traditional lever, but it is very important lever, that if you are not vigilant on that, you will lose some cost around it. So for me, both are critical, but gross margin is the heart of margin management. And NextGen is a program that we must execute to and get to end state on nondelivery cost, but gross margin is every morning, you've got to get out and burn some calories, otherwise you will accumulate some additional weight. That's how we see it.
Bryan Bergin
analystOkay. So naturally utilization, managing attrition very well and tightly is important to that. What about the delivery footprint of the company? Is there changes that you aim to make in that?
Jatin Dalal
executiveYes, absolutely. So we are largely -- from a delivery footprint standpoint is we are concentrated in India, we are concentrated in Philippines, and we are concentrated on Eastern Europe. These are the 3 big places. Within India also, there are hot spots on hot pockets, on attrition, which we structurally want to sort of avoid. Right now, it's not a problem. But when the industry goes back to a good demand situation, you would see that there are pockets which are far more driven by attrition and some pockets which are not. So we are trying to purposely go into Tier 2 cities to manage that better. So that's about the delivery footprint. Both geographically, globally, we balance it. But even within that, we manage it within the country footprint, how do we manage the cost a little bit.
Bryan Bergin
analystOkay. When we look at the industry gross margin over the last 5 plus, almost 10 years, there has been a degradation of gross margin in the industry. Cognizant included in it as well. What do you attribute that to?
Jatin Dalal
executiveI would say it's a factor of a couple of things. One is that the price pressure has been significantly more in last few years. I think the industry had a real opportunity in '21, '22 to retain some of the price premium it was receiving from customer, but at that point in time, none of us were prepared really for the growth that we saw. So we were all hiring from each other. And effectively, what we got a price premium from customers, we passed it on to employees in terms of making sure we are just fueling enough supply for the demand that we were seeing. So I think there was a point where we could have done something better, but we lost that window. I think there's an opportunity right now. I don't think there is a structural uptick possible that we should bake it in, because if there is a dollar which people can invest for growth versus passing on as gross margin, right now, the environment is that people -- I mean, the industry will invest for growth is my sense.
Bryan Bergin
analystOkay. And then when we think about near-term operating margins go through the balance of this year, you've guided to 20 to 40 bps of expansion. Any puts and takes as you go through the year that are important for investors to consider? And how do we think about the attribution of that between gross margin and SG&A?
Jatin Dalal
executiveSo you would see benefit coming from both sides. For the first quarter, we did slightly better than that for 20 to 40 basis points if you just see year-on-year numbers. Second quarter, we think we will be in a narrow range of performance of quarter 1. Quarter 3 would have salary increase and quarter 4 is typically our best quarter for the margin management, because we have some benefits around vacation days and stuff like that. But if you see the margin movement from here, you would see that it's coming both from gross margin and on SG&A for the rest of the year.
Bryan Bergin
analystOkay. And now assuming demand starts to recover at some point here, you're executing on a lot of operating and cost initiatives. How do you think about the operating margin framework of the business over time?
Jatin Dalal
executiveSo I think we are right now responding to the situation that we are seeing. And I think there is a certain context of today's situation to that. And as the context changes, I think we would be conscious enough to respond to that and figure out what is the right operating model for the cost. On SG&A side, I think it would be irrespective of -- I don't think we are going to take SG&A or G&A cost up, for sure, in future no matter what operating model is, but on gross margin side, we will have to remain responsive to the market. And therefore, I wouldn't comment it today. We will see what unfolds and then find a right response to that.
Bryan Bergin
analystOkay. Understood. Pricing, naturally, we know it's pressured right now, sometimes to be more flexible around that, there may be changes of contract structures. Can you talk about what you're seeing in conversations as it relates to fixed and non-FTE-based pricing relative to the historical time materials that the industry will be on?
Jatin Dalal
executiveSo certainly, more -- I mean, almost all the large deals are constructed on economic objective of reducing aggregate cost for the customer. Now if you're starting with that objective, which is very different than I want to launch a new digital bank in this region, it's a very different construct. And therefore, the price pressure is there from day 1 on the structure. So to that extent, I think price pressure is fine. And typically, that leads to more fixed price or more element-based deal outcomes. I don't think -- there are 1 or 2 specific trends there. Some deals are a little bit higher subcontracting. Some deals are a little bit more complex delivery given the geographical footprint. Some deals have an element of management of certain amount of licenses, et cetera. So there are not so attractive elements around every services deal, but largely 70%, 80% of the deal is around service delivery, and I would call the difficult elements around 20%. So that's what it is. I don't see a scenario where there is quality of deal has deteriorated so bad and we are still hungry as an industry or a company to go after it because we are starved of growth. So I don't think the deal quality has deteriorated significantly in terms of either the construct or the conditions of the contract.
Bryan Bergin
analystOkay. We have time for one more question here. So I'll pick 2 industries. So BFSI and health care, health sciences, certainly key industries for Cognizant. High-level view on those 2 industries as you go through the balance of the year and your expectations there?
Jatin Dalal
executiveSure. So within BFSI, BFS we are certainly seeing some amount of stability. It's not a bounce back yet, but if you see for quarter 1, our year-on-year growth was minus 6%, but sequentially, it was flattish or slightly negative. So there is a stability there. Health, we still had some growth sequentially in quarter 1. But there are many moving parts within health. I think life sciences is doing better, but there are certain sectors around pharma, health, which is not so well. So I think it's going to be more a mixed picture on health side as we go forward.
Bryan Bergin
analystOkay. Jatin, I appreciate all the detail. Thanks for the great conversation.
Jatin Dalal
executiveThank you very much. Thank you for having me.
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