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Cognizant Technology Solutions Corporation (NASDAQ:CTSH)

2013 Crédit Suisse Annual Tech Conference Transcript

December 5, 2013 11:00 AM ET

Executives

Karen McLoughlin - Chief Financial Officer

David Nelson - Vice President, Investor Relations and Treasurer

Analysts

George Mihalos - Crédit Suisse

George Mihalos - Crédit Suisse

Okay. So, I think, we are ready to begin. Thank you for joining us this morning. My name is George Mihalos. I cover the Data Processing and IT Services space here at Crédit Suisse. We are very, very pleased to welcome back Cognizant to our conference this year. And upon on the stage with me is CFO, Karen McLoughlin. I do want to point out that David Nelson is sitting in the audience there as well. Thank you for being here again this year.

Now in prior conferences like spend 10 minutes just going over the management compensation, okay, but you took it away from this year. So now I actually have to work for leaving for a little bit.

So why don’t we start off with the demand environment, you had a very, very strong 2013, slated for more than 20% topline growth? You spoke much more optimistically about discretionary spending now as a sort of existing the year? Maybe you can give us a little bit of color on what you are seeing globally geographically and also maybe the one or two sectors that are performing ahead of your expectations based on what you are seeing?

Karen McLoughlin

Sure. Thanks, George, and thank you for having us. 2013 really has turned out to be a very nice year. We saw this really at the end of Q1 going into Q2 where we did see a pick in discretionary spending with our clients. And if I talk about the pieces of the business and what we are seeing as I -- as a year has moved forward, really came from a number of areas.

If you go back into the middle of 2012, we really start to see a pick up in financial services and that trend has continued into this year. And in financial services what you are seeing is clients really looking to continue to optimize their cost structure but also needing to start to spend money on some of the regulatory work that they need to get done, also seeing a lot of work with clients around mobile solutions and financial services, and then also around analytics. So how can they use the data, they have more effectively to understand their customer base and what’s happening in their business.

In -- so that’s a very strong area of growth for us throughout this year. As we moved into Q2 and certainly into Q3 then, well, another area of strong growth really came from our healthcare practice.

And if folks remember back in 2012, in the middle of the year, we start to see a little bit of slowdown in healthcare after the Affordable Care Act was put into place, clients pull a little bit, trying to understand what the impact of the Act could be on their business and really took some time to work through that.

And then as regard into the middle of 2013, obviously clients understood what they needed to do support the Act that the timeframe that we are seeing in place and we saw a big pick up in spending from our clients as they look to be able to implement their pieces of the Affordable Care Act.

That’s very interesting work, because obviously, there is a, what we think a long tail of work that has to happen to support the Affordable Care Act. If you think about historically our business has been primarily on the payer side of the business and so our payer clients are having to interface with all of the exchanges as they come online with the various states, as well as the federal exchange, but also the states themselves are having to put in place their exchange programs and in the first wave only a handful of states that actually implemented exchanges over the next two years or so, we would look to see the rest of the states implement their state exchanges. So a lot of very interesting work going on in healthcare from that perspective.

So those are really the two biggest drivers of growth in terms of this year, but certainly the entire business of four mandatory segments have had very good growth throughout the year. From a geographic perspective, growth has been very balanced across our three major geographies across North America, Europe and what we call the rest of world, which is Asia and the Middle East.

But in particular, I want to focus on kind of Europe a little bit. So back at the end of Q1, we talked about an acquisition we had done in Germany, the C1 Group. We started to see some very nice traction there, but even our core kind of Europe business has really tried to see a nice pickup this year and starting to see some very good growth in Europe, very strong pipeline. Our clients in Europe are really looking at how do they significantly transformed their business, change their operating model, really drive down their cost of ownership, so that they can continue to be successful in a global environment.

And we’ve talked about this notion for a few years that we thought kind of Europe had the potential to be as big as North American and then it really is a matter of time as to when that pipeline would start to kick in the place and certainly that’s what we are starting to see now, so we are very positive on Europe.

George Mihalos - Crédit Suisse

So maybe, we will just take a minute there to govern Europe a little bit. Ex-acquisitions is a big part of the growth coming from your existing customers ramping spending with your or is it more new customer acquisitions?

Karen McLoughlin

In Europe, it’s actually got a very good balance of both. So we have seen a lot of new local activity in Europe. Typically in our business give or take 90% to 95% of our revenue in Europe comes from existing client as of January 1st of that year. But I would say in kind of Europe, just because of the significant growth we are seeing. And the brand recognition that we now have in Europe, we are seeing a much higher ratio were coming from new locals as we continue to penetrate the European market and we would expect that to continue for some time.

George Mihalos - Crédit Suisse

Correct. Great. And you also made some other positive comments on the three console regarding client budgets for next year. Looks like we may actually see an uptick for the first time in several years, maybe you can talk a little bit about your confidence in making that whole analysis you still going through the budget process?

Karen McLoughlin

Yeah. So, I think what we’ve said in our calls is that we would expect client budgets to be flat to slightly up and I think that will be industry specific and client specific. We are still finalizing budget process both internally and with our clients. But I think generally that sentiment holds true at this point. I think that's consistent with what others are hearing in the industry.

We always view that as a positive thing for us. The clients are really looking for these days is partners who can come in and help somewhat, what we call the dual mandates, so help me run better, help me drive cost efficiency and effectiveness into my business and also help me transform and innovate my business.

And so partners like Cognizant who can bring really that integrated set of solution offerings to clients bring that consulting capability to client are really what clients are looking for these days. And even if the client’s budget is flat that plays well because you can drive down their cost and they are still hoping their investment dollars to innovate.

George Mihalos - Crédit Suisse

So I think this year -- or last year when you spoke about going into a flattish budget environment for 2013, you still manage to do extraordinarily well. I think it’s 19% organic growth that you’ve been able to post now. Not looking for guidance but kind of thinking 2014 and beyond obviously, I would assume there is nothing you’re seeing that would cause your growth to decelerate in an environment where budgets will grow?

Karen McLoughlin

I mean, certainly we haven’t provided guidance there for next year but I think this trend again that I talked about of client’s looking for partners who can help them be more innovative, who can help them transform their business, bring this integrated set of solution offerings, bring me my consulting, bring me my BPO, my infrastructure and my IT solutions, really help me transform my business for the long term, it’s really what clients are looking for.

And given the main expertise that we have in the industries in which we serve and a very strong client relationships we’ve had historically, that tends to fare very well for us in terms of our ability to help our clients move forward.

George Mihalos - Crédit Suisse

So Cognizant and a handful of other tier 1 providers have been beneficiaries of vendor consolidation for many years now. Just wondering if you are seeing anything different than the competitive landscape, if maybe you are seeing some non-traditional players perhaps moving up a little bit in the stack and the capabilities that they can provide?

Karen McLoughlin

So I think you are right. I think vendor consolidation does continue that tends to be -- industries go through it in different cycles but we continue to see vendor consolidation. Again, it comes back to clients looking for partners, who they want a strong relationship with. They want people who can bring thought leadership. They want people who they know will stick with them, to help them solve their problems and that typically has been a very good opportunity for Cognizant and we continue to see that.

I certainly wouldn’t say that in the larger relationships that we’re seeing new competitors on the market, I think different parts of our business has some niche competitors. So some of our BPO work that we do that is very specialized to certain industries or certain types of processes you would have since smaller, more focused competitors in that space. That is the general rule of thumb, I think our competitors’ peer group is fairly whole.

George Mihalos - Crédit Suisse

Okay. Another part of that is we’ve been hearing more and more about these large transformational dealers that have been out there for several years, again probably more prolifically for last two years. Can you talk a little bit about why you think Cognizant has been able to outgrow its competitors? Other providers would also have these capabilities which we don’t seem to be putting up the growth rate that you have been able to continue?

Karen McLoughlin

I think a lot of it really comes down to, again, it’s about relationship, because when you are asking clients or when the clients asking for a partner to go on a transformational journey with them, there isn’t necessarily a one-side, that’s our solution. And these tend to be very customized solutions. You really need a lot of thought leadership as to how you are going to help the customer on that transformation journey and spend a lot of time partnering with them on that.

So, it really comes down to that customer relationship. It comes down to having the consulting front-end. So over the last five or six years we have put a lot of investment into our consulting practice, really making sure that we have build out that capability that we have folks who can really sit down at the table with the customer and really help them to think through a problem. And it’s not just an IT problem, right, it’s a business problem.

So, can you help bring me the right folks to the table who can work not just with the CIO organization but it might be with the operation’s team, with the finance organization, with the marketing organization and really get outside of just core IT and help me solve the business problem and make sure that you are bringing me the right solution.

And I think that there are only a handful of vendors and partners like ourselves who have really focused on building out that capability and I think that’s really a lot of what’s giving us the edge right now.

George Mihalos - Crédit Suisse

It’s good to hear. And maybe on that point again, you talked extensively about SMAC stack and your capabilities there? I think you put out a target of $500 million in revenue for ’13 coming from SMAC. How are you tracking compared to that? Does that feel conservative to you now given the traction that you have seen in the marketplace?

Karen McLoughlin

Sure. We are seeing great traction out of our SMAC stack for social, mobile, analytics and cloud. And as you mentioned earlier in the year, we talked about that that business was on track to do $500 million this year and we are still on track to do that.

I think what’s been interesting for us is the growth has been frankly a little faster than we expected it to be at this point. Certainly, over the next three to five years we would expect our Horizon 3 business as to become a meaningful part of revenue and to become a meaningful part of our growth story as we look out five years and beyond, and we are certainly on track to do that.

We are getting very good reception in the marketplace to some of the solutions that we build for certain industries and for our clients, and being able to take those solutions to market now. And that we are very, very excited about the progress we are making there.

George Mihalos - Crédit Suisse

Great. And maybe related to that, one of the concerns we hear from investors was obviously that as business model shift more cloud, more SaaS implementations that there is a risk of vendor disintermediation, lower maintenance revenue? How do you respond to those concerns and you see SMAC is more an opportunity or long-term threat?

Karen McLoughlin

Sure. I think for us SMAC is an opportunity and partially that's because of our history and where we came from. So, if you think about our client base today, these are large you know Fortune 1000, Global 2000 companies, so very, very complicated large operating platforms.

And so what we are seeing with our client base today is they are not able to move their big enterprise platforms to the clouds and that’s not really part of the conversation but what is part of the conversation is how do they create an environment where they can be more nimble, have apps that can -- peripheral apps, maybe they can go on the cloud, be more flexible, give them more agility, more nimbleness to move forward and to support their business. That actually plays very well into our sweet spot because we can help them build out that capability.

Over the long term, maybe some of the applications maintenance longer term get reduced for the core app maybe, but we think what will happen is in fact those dollars will get redeployed into new innovation, new transformation projects and that clearly has typically been a good thing for us.

George Mihalos - Crédit Suisse

So the trick is to win more valid share?

Karen McLoughlin

Win more valid share, absolutely.

George Mihalos - Crédit Suisse

That’s great. And maybe just kind of shifting gears a little bit more specifically to some of the verticals. You’ve managed to build the financial services vertical ahead of overall company growth, which is really impressive given it’s 40% plus of revenue, just wanted to talk a little bit about the drivers of that business, maybe how much of that is really driven by regulatory investment versus more discretionary things?

Karen McLoughlin

The thing about our financial services businesses is really two components, so it’s the banking side of the business as well as the insurance side of the business. And I think really what you are seeing is over the last couple of years, our addressable market within a client has actually doubled in size. So as we have expanded our service offerings as we have matured our product and our business that has given us the capability to branch into lots of other areas within our financial services and other clients. And I think that’s a lot of what you are seeing today.

So, if you go back five or six years ago, our BPO and our infrastructure and our consulting businesses were nascent businesses. Today that’s 20% of our total revenue and so a lot of it is really around service expansion both in banking and in the insurance practice.

In banking, you are seeing some regulatory work but that is just a piece of the growth story that we are seeing. A lot of it is around additional service offerings, some of the transformation work and some of the work that we are doing around the NASDAQ. So it’s a very nice, I would say, a broad range of service offerings and global expansion as well.

George Mihalos - Crédit Suisse

That’s great. And maybe just to ask one more regulatory question. Are you getting more of a push from Dodd-Frank or Basel III implementations or are they one and the same essentially?

Karen McLoughlin

So that is some of the work that we are doing for our financial services clients. Regulatory work has always been a big part of our work with our clients because we have such a strong demand expertise, so when there is regulatory work going on we tend to get certainly our fair share of that work.

George Mihalos - Crédit Suisse

But is that not one more than the other based on your…?

Karen McLoughlin

No. It is very client specific so.

George Mihalos - Crédit Suisse

Okay. That’s helpful. And focusing a little bit on the healthcare business, obviously that had a beautiful start in the third quarter, was nice to see that come back. Can you quantify or give us a sense, how much of the revenue acceleration was really the target of Affordable Care Act?

Karen McLoughlin

So, I mean a lot of the acceleration that we saw in Q3 was really, did in some form or another say, Affordable Care Act. What you saw was not just IT work so, a lot of it is also BPO work, so trying to actually get people on board and on to the programs. Our customers are looking at how do they manage all these new members that they will be getting as a result of this. Obviously, you are seeing a very nice combination of BPO as well as IT and then the interesting thing around the Affordable Care Act is that the next couple of years is just a lot of working that has to do just to implement the program and get the program up and running.

But our hypothesis is that once soon as the basics of the program are up and running, really the next phase of this is really clients looking at how do you really change healthcare delivery in United States, and how do you really drive down the cost of healthcare that can continue to deliver great healthcare quality in the United States. And so the lot of work the clients are trying to think about around that, a lot of consulting opportunity obviously that comes with that as we try to help clients think about what the future of healthcare really looks like.

George Mihalos - Crédit Suisse

So it certainly sounds like the push out of some of these important mandates has not had any impact on your business there?

Karen McLoughlin

Not at this point, no.

George Mihalos - Crédit Suisse

Okay. Okay. And you talked about the pharma business a year ago being weaker and the healthcare business underperformed for the last four quarters relative to the rest of the business. Has pharma bottomed now and maybe you can talk a little bit about how you think about it in 2014 based on the clinical pipeline that are out there?

Karen McLoughlin

So, life sciences, certainly is growing slower than the company averaged this year, but it is growing double digits. So it is certainly not that we have seen a pullback or a shrinkage in our life sciences practice. It is just relative to the rest of the company. I think at this point I think it is early to say what happens in ’14, although I think certainly I would at this point I am not expecting in the beginning of the year that there will be any sudden turnaround in the life sciences.

I think formers clients are also undergoing a lot of transition and turmoil in their business. I think it will be dependent upon how their pipeline recovers, whether that’s later next year or into 2015. But certainly at this point as I said, it is growing double digit, they are growing slower than the company average and in the short-term I would expect that to continue.

George Mihalos - Crédit Suisse

Why don’t we pause for a moment to see if there are any questions in the audience?

Question-and-Answer Session

Unidentified Analyst

Hi. Can you talk about U.S. hiring plan? You recently announced 10,000 employees in U.S. Can you also touch on the mix of visa holders and the U.S. nationality in the state and offshore versus onsite and how do you keep the same cost structure and the margin structure and ramping up U.S. hires?

George Mihalos - Crédit Suisse

Sure. So, let’s start with the second question. So we do not provide a breakout of visa holders in the U.S. versus citizen and Green Card holders for variety of reasons. But in terms of our onsite offshore ratio, it’s typically about 70% -- little over 70% of our staff or offshore. Offshore being defined as India, the Philippines, China et cetera and little under 30% of onsite, whether that be Europe or North America or somewhere else.

In terms of the hiring plans that we talked about on Monday, we were excited about the things we are doing. As many of you may remember, back in Q2, we purchase this company by the name SourceNet, which is based on the College Station, Texas.

And on Monday, Gordon Coburn, our President was down there to talk about a new innovation. We’ve entered into with Texas A&M providing funding for STEM education over the next three years to Texas A&M and we’re very excited to able to announce that opportunity. Along with that, we did talk a little bit about some hiring plans here in the U.S. and what we had said was that over the next three years, we expected to hire at least 10,000 people here in United States.

That is frankly very consistent with the hiring that we’ve had in place now as we’ve -- since the last few years, really looking at how do we build out our talent around the world. That’s about the finding the right talent in the right countries to support our clients. So historically we do that through a mixture of on-site hiring.

Here in the United States, we have a very robust college hiring program and MBA hiring program as well hiring of lateral experienced folks. And then we supplement that both here and also in the world with global relocations as we need to provide the resources for our client. So this is really an extension of what we’ve been doing for the last few years.

George Mihalos - Crédit Suisse

Thank you. I wonder if you could just touch on this, as you building out your cloud franchise, how are you going about it working with the incumbent traditional vendors versus some of the newer, let’s call, clouds startups. How do you sort of look at the business? Where do you partner and how do you see that business growing?

Karen McLoughlin

So first, cloud takes on many forms. We do have on cloud offering which is Cloud360 which really helps the clients bring together their private and public cloud offerings under one umbrella.

So that is one solution that we can bring for our clients but a lot of the work we do for clients is really around working with other partners with their cloud partners, helping them develop those roadmap for how they’re going to use the cloud moving forward, helping them make those transitions as necessary, helping them leverage across multiple partners.

So, very consistent, frankly with how we run our business in the past, where we can remain very product diagnostic. We work with many partners in the industry and really work with our clients to help them optimize the right position for them.

George Mihalos - Crédit Suisse

Any other question before (inaudible) time. Okay, there we go.

Unidentified Analyst

In terms of -- thank you. When you have an ERP deployment on SAP versus your cloud base deployments, can you share how your revenue is different in a cloud base deployment? And what kind of a headwind that could be for you as cloud business becomes bigger for ERP deployment?

Karen McLoughlin

So I think the difference for us versus some of our larger competitors is that, in fact, if you go back 5, 10 plus years ago, when people were doing the very large ERP implementations, Cognizant frankly wasn’t in those transactions. We may have had a very small piece of the project but if you think, 10 years ago, we were not even a $400 million company.

So we were playing in those very large ERP implementation today that we would have niche pieces of the implementation and maybe we’re doing some of the application and maintenance work.

So as the business shifts and as some of that type of work changes and maybe the size of those projects comes down overtime, it’s actually playing into our sweet spot. Because we are now at a scale, where we can actually step into the larger projects and so these types of cloud projects, more customized applications or whether it would SaaS products, the customers are implementing.

Its very core to how we’ve grown our business. And so from our perspective, this actually isn’t a headwind because we didn’t have that big legacy business that maybe some of the other firms had and that’s true, both on the ERP side of the business as well as even on the infrastructure side of the business because we just want in those very large deals that happened several years ago.

George Mihalos - Crédit Suisse

So I think, we probably have time for one more question. Is anyone out in the audience? Right, so why don’t we end it on capital allocation, another fun topic. Maybe talk a little bit about what you’re seeing in the acquisition pipeline and how you go about considering geographic acquisition versus technological?

Karen McLoughlin

Sure. So we are constantly looking for what we call niche or tuck-in acquisition. And for us that can be a geographic acquisition. So we’ve done two in Europe this year, those have been acquisitions that they have been looking for quite some time. We’ll niche service offering acquisition. So we’re -- again where we can find good consulting acquisitions, we think that makes a lot of sense for us.

Other niche scales in the BPO space, for example, the SourceNet acquisition bought us an AP platform and so that was really important to us to help build out our BPO capability. So I think, you’ll continue to see us look for acquisitions where we can build out capabilities, geographic skill sets. And I think, in the future, we will also -- like to look from the IP-based offerings.

So I think you’ll see us continue to do that. For us, we talk about niche, tuck-in acquisitions, we are not looking for scale acquisitions, but obviously as we get bigger, the definition of what is a niche or tuck-in acquisition can get bigger. So certainly the C1 acquisition we talking about, was over a $100 million of revenue, doing a 200 million-300 million type acquisition at this point and the scale is very achievable.

We would certainly like to continue to do more acquisition. Over the next few years, we think, there are some good opportunities for us to continue to build out our capabilities and its really about can we find the right transactions at the right value.

George Mihalos - Crédit Suisse

Great, well I think we have to stop there. Karen, Dave, thank you so much for your time.

Karen McLoughlin

Thank you very much.

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