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

Perfect. Good morning, everybody. Welcome to the Goldman Sachs Communacopia Internet Conference -- Technology Conference, excuse me. My name is Jim Schneider. I'm the IT services analyst here at Goldman Sachs. It's my pleasure to welcome Cognizant, as well as Head of Americas, Surya Gummadi and Head of Investor Relations, Tyler Scott. Welcome, guys.

Thank you, Jim. Thank you for having us today.

Thanks for being here. Surya, for those of you in the audience or listening who have not had the opportunity to meet you, can you maybe give us an introduction of yourself, your history with Cognizant. I actually think it's a very interesting history and your responsibilities as Head of the Americas.

Sure. Good morning, everyone. I have been with Cognizant for a long time. This is my 25th year with Cognizant. And in many ways, I joined Cognizant when Cognizant was a start-up, a very small firm. And I grew with Cognizant. And I saw the evolution of Cognizant. I saw the stabilization of Cognizant. I saw the hypergrowth of Cognizant, and the next phase of Cognizant and now the selection of Cognizant. So I have worked across the firm. I have worked across different functions of the firm. I joined as a business analyst back then. And since then, I have worked in sales, presales. I've worked in client management. I was a client partner, BU head, ran a few of our businesses before I took on my current role as the President of Americas. Americas constitute roughly 75% of Cognizant today. So I run the entire P&L for Americas and from soup to nuts from -- which includes owning their client relationships, accountable for delivery to the clients and managing the P&L for the Americas. That's my current role.

I think it's been 18 months or so since -- or after, since your CEO, Ravi Kumar, was appointed. He's been pretty explicitly focused on sort of rejuvenating revenue growth. We've seen early traction with large deals. Give us a sense of how this major turnaround has gone so far. Specifically, what's worked, what hasn't?

Yes. I think -- yes, you're right, it's been 18 months since Ravi took over as CEO. It was on -- since his first day, the focus has been on growth -- the growth. I think there are 3 or 4 key dimensions that have changed in the firm in the last 18 months. One is obviously, as you said, the focus on growth, there is unprecedented focus on growth. We have invested in the large deal infrastructure for the firm. We have invested -- we have re-overhauled the sales engine, the front-end teams. We have done a talent refresh across the firm to rejuvenate our sales engine. That is one part. The second most critical part is establishing or reestablishing the channel of trust with our clients. There was a little bit of -- we were dealing with a little bit of a trust issue at that point in time. In the last 18 months, we have focused on reestablishing the trust. How did we do that? By showing up well, by winning the mind share, by delivering high-quality products and being more agile and responsive to our clients. So we have focused on that. And Ravi also has focused on the culture and employee morale. So we got the culture of innovation, the grassroots innovation. We have launched a program called Bluebolt, which was his brain child and that hit off really well, both internally and externally. So the culture and the morale, you see other aspect. So there are 3 or 4 dimensions that he has focused on, but everything channel towards growth and making sure that we have healthy morale across our workforce. As you know, we have 345,000 strong workforce. We just got to make sure that they're highly motivated.

Yes. I mean you're in a great seat to assess this question, which is basically from where you sit, how is Cognizant positioned against your competitors today, especially in the Americas? And what improvements could we sort of expect out of the company over the next 12 to 18 months?

So I mean going back to your previous question, over the last 18 months, competitive positioning in the market has significantly improved. And just a proof point to that is, in the last -- last year, we won a total of $1700 million plus deals. In the first half of this year, we have won $1300 million-plus deals already. So our competitive positioning has improved. We are participating in a lot of -- much more large deals, more proactive and reactive. So that way, I think -- and we have invested in capability building across led the GenAI. I think we are one of the very first IT services firms to pledge $1 billion investment into GenAI and we have doubled down on that. We have followed through on that. And we have built capabilities around that. So we have focused on underpenetrated markets for Cognizant, and we started expanding into those markets. A combination of all of this has improved our competitive positioning significantly over the last 18 months.

Now with the global economy still a little bit uneven, we've got inflationary pressures, potential slowdowns in some verticals, how do you view the state of the market? How are you positioning to kind of adapt to those shifts? And what are you really doing to drive resilient growth in this challenging environment?

I think you're right. I mean, the global economy is still volatile. We are dealing with 4 variables [indiscernible] the U.S. elections. obviously, the interest rates, inflation and the geopolitical tensions. These 4 variables will have to level out over the next few quarters to see where we all end up with the economy when it starts rebooting. While that is happening, we are focused on a few things. We are focused, as I said earlier, we are focused on expanding into underpenetrated industries for Cognizant, such as communications and media, aerospace and defense. That is a completely new segment for Cognizant. We have invested in our new asset recently to expand into that market. And then we also started expanding into adjacencies by building our capabilities. We have recently launched our experienced star, Moment. And we have -- we are incubating service security offering. So these are the adjacencies that we have. We are focused on -- so we are trying to build the capabilities, expand into markets that we are not present today and revamping our sales engine at the same time so that we are ready when the markets open, we are fully geared up and gassed so that we can participate in the race [indiscernible].

Yes, yes. And then despite the weak discretionary environment, it seems like clients are still spending maybe different projects, different priorities and scopes, but they're still spending. So I mean, what has shifted in the way clients are prioritizing their spending?

In the -- over the last 12 to 18 months, the spending pattern has changed from our clients. The clients are more focused on cost optimization, and so they are more -- they have called a vendor consolidation play to a great extent. As a result, we have seen many large deals, a ton of large deal activity in market around vendor consolidation and cost optimization. So we have done well. We have done well in that segment. We have won our fair share or rather unfair share of some of those deals across the businesses. So I expect this to continue -- I expect this pattern to continue for the next few quarters until the discretionary spend comes back. We have seen the trickles of that coming back in some of the industries but many of the other industries continue to remain soft. And there is no significant departure in the discretionary spending pattern. So the clients will continue to -- probably will continue to focus on these cost optimization deals for the next 2 or 3 quarters.

Yes. And how are you sort of adapting your service offerings to kind of align with those shifts? And in what areas or do you see the most potential for growth?

See, for example, for us to participate in these large deals, we have to make sure that -- we have to make sure -- in fact, we made sure that our front end, which is our sales engine, is strong. And then we have supported that with our investments in some of the benchmarking or pricing and some of the other elements that are absolutely essential to position ourselves well in the large deals. That is on the front end. And then once we win the deal, we have to focus on executing the deal. So we are focused on strengthening our delivery measure, and we are focused on the governance for executing these large deals. So that is one area of focus for us to do well in this market. Along with that, we are focused on expanding into adjacencies or to address some of the capability gaps that we have. To your question, I think we expect ton of activity in AI and GenAI-related areas as the market opens up.

We'll get there.

Yes, we'll get there. That's a good segue to that. But there is a lot of activity in the security space. I mean we -- the other day, we hear -- read something in the market. So clients are focused on wall-to-wall security. So we are focused -- we are partnering with some of these platform providers and coming up with service offerings for security. And that is one of the focus area for us right now, along with Experience and few other areas that I mentioned.

Yes. Now this market is obviously a highly competitive. You're still very well positioned in your major markets like financial services, health care, you talked about this a little bit. How are you sort of defending and potentially expanding your share, each of those 2 verticals?

Yes, you're right. I mean, financial services and health care segments have been very large markets for us for a very long time. In fact, the health is a very big segment for us. In health care, we have a unique differentiation in the market. We have platforms. We have our TriZetto branded platforms. And roughly 2/3 of United States insured population is processed on our TriZetto platforms. There is no other platform like TriZetto on the planet. So that provides a very unique differentiation for us to offer bundled solutions or end-to-end solutions to our clients. That's a very unique differentiator that would -- that is helping us, and that will continue to help us in the health care market. Similarly, in the financial services, we have deep domain expertise. Over the years, we have built deep domain expertise in financial services. And we are coming up with tailored industry-specific solution offerings and financial services. That is going to help us. And in fact, that is starting to show results for us to strengthen and further expand in the financial services.

Yes. And are there any kind of idiosyncratic opportunities that you're seeing to take share while sort of the overall discretionary environment is still depressed?

Still -- again, in health care, we are leveraging our platforms to proactively construct end-to-end solutions to our clients to help them optimize their costs and also help them with the faster time to market and gain the competitive advantage. Those are such opportunities that we are crafting ourselves and taking to the clients. And that -- we will continue to do those. In health care, it really helps because we have platforms, whereas in the other business segments where we do not have platforms, we are leveraging our domain expertise and our partnerships with hyperscalers to build end-to-end solutions and create those opportunities. To take that fair share away from the competition.

Yes. Now, just 3 months ago, you announced the acquisition of Belcan, and that represents kind of an interesting diversification into new markets for you, aerospace and defense. It's been an area where -- it's been a while actually since we've seen an acquisition of this kind of scale. So how does that fit into your broader M&A strategy?

So Belcan addresses 2 aspects of our strategy. One is the vertical part, which is aerospace and defense. These are the 2 industry segments that Cognizant does not operate today. We do not have any presence in those. So this fills in that void or a gap for Cognizant, which is the vertical part. Horizontally, it strengthens our ER&D muscle, engineering muscle. We do have that capability in Cognizant today. With Belcan acquisition we have enhanced that capability so that we can serve it across the industries, for example there's engineering-related -- we do engineering-related work in life sciences, manufacturing and utilities and in other segments. So it helps -- it kind of fits into our strategy of expanding into markets that we're not present today and strengthening our capabilities to serve. And we are very optimistic and positive about that acquisition, and we look forward to delivering that.

Jim, maybe just on the broader M&A question and sort of capital allocation question. I think as we've kind of executed on this framework for a number of years, this balanced approach on sort of return of capital to shareholders and investing for the future through M&A using our balance sheet and cash flow is going to continue. So we've talked about roughly 50% of our annual free cash flow going towards M&A, roughly 50% going back to shareholders in years past where M&A has been a little slower, we've kind of reallocated, and done a little more share repurchase. I think this year, we're probably going to be on the opposite side where we're doing a little bit more M&A than we typically have the last several years and therefore, a little more aligned on the share repurchase to the roughly 25% of free cash flow. On the earnings call we mentioned I think Phase 1 is sort of integration of Belcan. And so in the near term, not expecting any material acquisitions for the remainder of this year. But I don't think this prohibits us from kind of remaining active in the M&A market and sort of evaluating opportunities as they come across.

Yes. And as you integrate Belcan into your operations, sort of what are the areas of focus for innovation in the first 100 days? I'm not sure why I say 100 days. I've got politics in the brain maybe, but for several months.

Actually, I mean, Belcan is probably the -- one of the large acquisitions that Cognizant has made after TriZetto. We acquired TriZetto in 2015 that was a larger acquisition then. So the focus for the first 100 days is going to be, again, stabilize and grow. Growth is the focus with the controlled and calibrated integration. So we're going to focus on growth and synergies. So for -- in the first 100 days, you're going to look at the opportunities to upsell and cross-sell Cognizant services into Belcan clients and vice versa. So we have a dedicated team from Cognizant assigned for Belcan, and again, the focus is on growth with calibrated and controlled integration. And we have announced that we're going to -- we are looking for at least $100 million synergies over the next 3 years by upselling and cross-selling Cognizant capabilities into Belcan clients and the reverse. Good news is we do not have too many common set of clients today. So that gives us a greenfield opportunity for us. and we are retaining the Belcan brand so that there's absolutely no client disruption in the market in whichever way. And so that way, I think we can solely be focused on growth and make sure that we supplement Belcan with Cognizant's strength of global delivery model and the other aspects of very robust hiring engine and things like that.

Very good. Maybe I just want to pivot a little bit and talk about AI because you raised it earlier. Given the market focused on Generative AI, we've seen some early traction. I think you've talked about 750 early client projects, sounds to me like most of those are sort of the early prototype phase at this point. Maybe talk about the kinds of projects that are included in these early engagements, first of all?

We are seeing GenAI projects in 4 vectors. You're right, I mean, the projects are still small and prototypes kind of nature, but we are seeing them in 4 vectors. The first is customer experience. So many of our -- this is -- in fact, this is the vector which is very predominant. Most of our clients across industries are doing projects and pilots and many of them are in production in the customer experience sector. This includes all call centers or anything related to customer experience. The second vector is more around content, content generation, content creation, content dispersion and things like that. So there are a ton of projects in that segment. The third vector is more on the efficiency and productivity, which is -- it could be tech for tech or the other aspects to drive efficiency across the value chain. There are projects in that. And the fourth vector is [ far and few ], some of our clients who have deep pockets and who want to dabble with this technology are looking at leveraging this technology to create new revenue streams, and new business models and things like -- for geographic expansion or taking products faster to market and things like that. So these are the 4 broad vectors where we are seeing projects on GenAI today. And most of the customer experience-related projects are getting into production. Not at -- I mean, relatively, that is the faster and the broader -- we see the faster and broader adoption of GenAI in that segment.

Interesting. and the rest of it, maybe just talk about -- or even in the first one, customer experience, what is it taking to kind of get to the next level in terms of scale of projects? Do they have to see, hey, there's real cost savings here? Is it some new capabilities? Is it remediation of data stacks? What is it kind of get them over the hump to a bigger project?

I think in the customer experience sector, clients are adapting or consuming this in an incremental way rather than an exponential way. I think most of our clients have deployed this technology to some extent in customer experience sector. To your question on why is it not at scale in the other sectors or other dimensions, I mean probably 3 or 4 reasons. Many of the clients are still waiting for the maturity in the technology to a great extent. And then there is this regulatory aspect of the technology. Clients are not very clear on the boundaries of the regulation. And third, this is -- we still see a ton of activity when it comes to GenAI spending at the chip and infrastructure level. So that's why you see a lot of activity with the hyperscalers and the chip manufacturers like NIVIDIA. It still has not creeped up to the applications layer and the business transformation layer. We expect that to happen over a period of time. And it still has not triggered CapEx cycles, probably because clients have overspent on cloud and are still waiting for benefits from cloud. But once the technology jumps the S-curve from chip on infra layer to apps and business transformation layer, we expect more broader and widespread adoption.

And what's your own outlook for the sort of the time frame for broader enterprise-wide AI adoption?

I mean it's hard to call, but seeing what we are seeing, knowing what we know. It also depends on the economy. Assuming economy comes back sometime in 2025, if I were to pick a time frame, I would pick somewhere from 18 to 24 months for a widespread broader adoption for CapEx cycles to trigger on this.

I guess what kind of projects do you think are going to be most impactful for clients once we sort of get past this proof-of-concept phase and cost takeout deals? And how meaningful do you think it could be to your growth over time?

I would look at it with a different lens. I mean I wouldn't look at it from a project lens, but I would look at it from a value chain lens. So this technology has to be -- like digital, for example, you can't digitalize components of your value chain. You have to digitize the entire value chain to reap the benefits. In a similar way, you'll have to infuse this AI across your value chain. For example, if you take a health care payer value chain, insurance company value chain, the value chain has multiple components, such as, a sales and marketing member onboarding, claims administration, claims payment and all the way up to the provider touch point. So once you infuse GenAI across, then you will start reducing the cost of care and improving the quality of care. If you infuse technology in parts of it, then the benefits will be incremental. So that's what happened in digital. They started in an incremental way, but then clients started digitizing their entire value chain. They started redoing their entire plumb line across infra business and operations layer. That will trigger large-scale projects. So we'll have to take -- we'll have to look at it from a value chain-centric model or approach, and that will trigger larger projects.

Got it. Okay. So if you think about this internally, how is Cognizant sort of used AI to sort of enhance productivity, differentiate yourself in the market so far?

So we have deployed, the GenAI within Cognizant to -- I guess we have to eat our own dog food too. So we have deployed it in 2 or 3 areas. So obviously, for the employee experience part, we have deployed that. We have deployed that in some of our HR segments such as employee onboarding or for any training or Q&A aspects for the employees. And then we have deployed this technology for our internal tech support. So we have deployed that. And we have also -- we have deployed it for the content-related elements, creating training materials and things like that. And now we are beginning to deploy that on the sales side for the RFP response or case study creation and things like that. So we have deployed it in 3 or 4 different areas within Cognizant. And we are seeing results -- good results for that through that. This is within Cognizant. Obviously, we are deploying this technology to serve our clients. That's a completely different element to it.

Yes. I think it's fair to say that emerging technologies like GenAI sort of always bringing significant opportunities, but also kind of -- there's this debate, and we've had debates like this whole conference long about whether AI revenues are eventually going to live up to the hype or not or at least justify initial investment. I mean for Cognizant, what milestones do you think we should be watching as we get to 2025 and beyond, that will give us great confidence in the trajectory of those turning into revenues?

I mean it's very hard to define or -- very hard to say that this is going to be the yardstick for AI success at this juncture. To me, I mean, the biggest proof point would be that when -- actually, let me take it back. This AI is expected to push growth by 3 to 4 percentage points beyond the traditional market growth. When you start seeing those growth rates from the services firms. That's when you begin to realize that AI is doing its magic or AI is delivering its expected hype. Otherwise, beyond that, I mean, you can talk about the number of projects or revenues generated from projects or AI in projects, it's very hard. Today, I can't. Almost all the large deals that we spoke about earlier, has a component of a AI, or GenAI.

Sure. So revenue acceleration. Just like SaaS and cloud. Revenue acceleration, that's how you know it was real.

Yes. When the growth rate starts pushing beyond the expected market growth rates, that's when you know that AI CapEx cycles have triggered.

Maybe some more kind of operational financial-related questions. You've instituted the NextGen program to drive significant M&A cost take out across the business. What inning do you think we are in? Or maybe -- why I used cricket analogy, I don't know, to sort of like kind of respect to like those overall cost reductions and how much room for sort of absolute dollar reduction in SG&A, do we have from the current levels?

I'll let Tyler also chime in on this question. To answer your innings question, probably we have just concluded the first innings or we are getting into the second part of it. NextGen, the savings from our NextGen are kind of channeled into 2 or 3 buckets within Cognizant. One is investment in large deals. As I said, we have focused on investing or bulking our sales engine or revamping our sales engine. So some of the NextGen benefits have been channeled towards that. And the other element is for our training and infrastructure-related elements and a portion of that flows into our bottom line too. I think we have seen 70 basis points improvement in our bottom line in the first half. So these are the 3 dimensions through which the NextGen is helping us. And on the broader...

Yes, I would say over the next 2 quarters, we still have kind of incremental NextGen actions that are coming online when we had introduced the program last year, we had talked about achieving approximately $100 million of savings simply from the real estate. Now you've seen the charges for real estate exits -- lease exits and things like that, that the savings are really kind of starting to roll online in the middle of this year and through the end of this year. So we expect to achieve that $100 million of annualized savings in 2025. We have incremental sort of head count and more traditional overhead actions that are happening over the next 2 quarters. And so we're going to be kind of exiting this year, concluding the program, right. I think that we would expect to at least be through NextGen by the end of this year. A lot of these investments, Surya spoke about where they're going into. It's also helping us. We just went through a merit cycle, right. We had talked about in Q3 absorbing a merit cycle. So some of it goes there, right? Of course, it's -- we haven't talked about pricing, but it's been a tough pricing environment. So it's helping fund some of the investments that we're making on the large deals, go-to-market and other things while trying to kind of accelerate revenue growth. And so I think the end of this year, kind of the conclusion, we haven't given the SG&A dollar piece, but I do think it's fair to assume we do have some incremental actions kind of exiting this year and then next year trying to drive some operating leverage with better revenue performance and slower SG&A growth.

Actually, on that note, I would like to expand on -- if you -- we have defined a strategy in 3 pillars. One is accelerate growth, become the employer of choice and modernize our operations. So we are executing our strategy flawlessly across and the NextGen is kind of helping us to a great extent. On the accelerated growth, we spoke about our focus on the large deals, having the channel -- or winning the channel of trust with clients, expanding into adjacencies, expanding into the markets that we are not present today, focusing on underpenetrated markets. Those are the 4 or 5 elements of accelerating growth element of our strategy. And when it comes to becoming an employer of choice, we are focused on multiple employee engagement initiatives. Part of what was the hikes when not many people have awarded hikes, we kind of went ahead with that. And then we are focused on learning and development infrastructure for our employees to improve the morale of the employees. We have said that we are going to invest in training campus in India and also in U.S. And so things like that. I mean, just to make sure that we retain and attract the right talent that is become an employer of choice. The third element is modernizing the operations, which includes some of the platforms that we have built for enhancing our delivery effectiveness and delivery industrialization and some of the investments that we made towards a large deal infrastructure. And we are doing a lot of other things to be more agile, more nimble and to improve our competitive positioning in the market. So I think these 3 elements of our strategy, the NextGen dovetails well into all the 3 pillars of our strategy.

Yes. Yes. Your revenue trajectory has already started to improve. What is your outlook for kind of sustaining improved revenue growth this year and more importantly into next year? And sort of what are the key levers you're pulling and focusing on to kind of achieve that?

Listen, I mean, a lot of it depends on the economy, too, like we spoke. But coming to Cognizant, what are we doing to be fully ready when the race begins is, we just want to make sure that we have unfair share of client -- of the mind share of our clients. So through our AI and GenAI and through our domain expertise across the market segments that we operate in, we are constantly monitoring where the puck is moving in each industry. We are making sure that our capabilities are aligned to the market. If there are any gaps, we are focused on building those capabilities and plugging those capability gaps. That is the first part. Second, we are leveraging our large deals engine and our competitive leverage in some of the industries and the industries that we are growing to make sure that we stay highly competitive and reasonably aggressive to win some of those large deals. That's the second element. And then we have called an M&A play. For example, Belcan is one part of it. So we are focused on executing to make sure that we have a strong foothold in aerospace and defense, and we expand our engineering muscle across that is the third element. And fourth, we are making sure, while we are trying to win the market, we want to make sure that our delivery engine is primed to the right level. So we are focused on delivery industrialization, automation, and agility within the delivery infrastructure to make sure that delivery engine caters to the sales. These are the 3 or 4 things that we are doing to keep ourselves fit and fully ready to jump in when market opens.

Yes. On the margin side of things, large deal wins, those are good. You've talked about them. They also involve upfront costs, especially the larger outsourcing deals. So how are you thinking about balancing sort of the short-term margin impact with a long-term revenue growth?

You're right. I mean, these large deals are long tenure deals, okay? In the first year, we will have a bit of a margin issue. But we have planned through that. We have balanced through that with a bunch of -- 2 or 3 things. One is the NextGen, that we spoke about. A portion of NextGen returns are being used to balance that. The second element is usually when the discretionary spend is high, we tend to carry a larger bench. And now that discretionary spend cycles are compressed, we don't need to have the bench that we used to. And historically, Cognizant also is a little on the higher side when it comes to the bench cost. So we have optimized our bench and use that benefit that we got from that to balance some of this issue. So NextGen, balancing the bench cost, and we have -- we are focused on driving the automation across our delivery framework. We are -- either through GenAI or otherwise. We are dialing up the automation lever to make sure we get benefits of that. A combination of 3 of these vectors is helping us balance that short-term margin issue, while we are focused on addressing the long-term revenue backlog through these large deals. And at the same time, the -- and as the years passed, as when we get to year 2, year 3, the automation levers will kick in, in these large deals and the GenAI advantage will come in. And that should help us in [indiscernible].

Great. I've got more, but unfortunately, we're out of time. That was a great overview of business. So Surya, Tyler, thank you very much for being here. We appreciate it.

Thank you, Jim.

Thank you.

Than you. It's a pleasure meeting us today. Thank you.

Pleasure is ours.