Cognizant Technology Solutions Corporation (CTSH) Management Presents at RBC 2019 TIMT Conference (Transcript)

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Cognizant Technology Solutions Corporation (NASDAQ:CTSH) RBC 2019 TIMT Conference November 19, 2019 3:30 PM ET

Company Participants

Karen McLoughlin - Chief Financial Officer

Conference Call Participants

Dan Perlin - RBC Capital Markets

Dan Perlin

Go ahead and get started. Thank you to everyone who's here. Again for those of you whom I've had -- not had a chance to meet, my name is Dan Perlin. I cover the payments processing and IT Services Space here for RBC. And I am delighted to have joined us with the management of Cognizant and Karen McLoughlin, Cognizant's CFO. So I wanted to just jump right in. First I want to say thank you for being here.

Karen McLoughlin

Well, thank you for having us.

Dan Perlin

Very much appreciated. But I want to jump right in kind of a high-level, because there has been, I would say, an enormous amount of change that has taken place in a relatively short period of time. I think there seems to be a real renewed interest in what's kind of taking place around Cognizant. But what we can't see as investors and analysts on the outside is kind of what's happening from the internal perspective. So if maybe you could share how maybe some of those cultural changes have started to take place and what that means with all of this management change?

Karen McLoughlin

Sure. So good afternoon everyone. Brian Humphries our new CEO joined us on April 1, so he's been with us almost eight months now at this point. It's been an interesting few months since Brian joined. Unfortunately when he joined in April, it was not the best time in the company's history. We unfortunately had to take down our revenue guidance for 2019 and missed our Q1 number.

So that was not something that obviously we take lightly as a company. That’s the first time in the company's history that we have missed the numbers, and I think a number of things were going on at the time, including I think some distraction over the last few quarters before Brian joined. Around CEO transition, we had a number of clients in our healthcare business that were merging and that created some disruption for us. And so when he joined he had a bit of a surprise I think that perhaps, there's a little more work to do than he originally anticipated.

But for those you know Brian, he got right to it and really started digging in and trying to understand what was working well in the company, what was not. And really thinking about the strategic vision for the organization and where do we want to take the company and that's what we really spent the better part of the first six months that he was with us focusing on.

And I think in terms of some of the changes that we're seeing, I mean certainly earlier in the year there was -- there were some executive departures some of that was by design, some of that was planned for even before Brian joined. He himself came in and made some changes very early on in our banking and healthcare practice. And I'm happy to say that with the changes we’ve made that most of those positions have been refilled either internally through promotions in many cases with our own team, or in a couple of cases like our banking and healthcare practice where we went to the outside and brought in some fresh talent from the outside.

But most of those changes are behind us. We have a couple of more folks that will join us in the coming weeks, but you can start to feel the organization now get sort of back-to-business. And Brian's message really from the first day has been how do we get the company back to more normalized growth trajectory. And certainly competing at least at market if not better than the marketplace. And so that has created a lot of energy inside the organization.

At the same time, we're also looking at the cost structure of the organization. And like any big company who's had a lot of success over the years, there is certainly room for improvement and we have identified some areas where we believe we can streamline the cost structure, particularly our cost of delivery and some of our SG&A functions across the company, which will then give us the ability to invest for growth going forward.

So we do have a number of things going on at this point. We talked about a lot of them in our Q2 call in terms of how we're investing in new sales efforts for to drive the growth, at the same time driving some of these optimization efforts. Our objective is certainly to get as much of this cost optimization behind us as quickly as we can. So we can sort of say we're done to the extent you can ever say you're done with those things, but really continue to drive the focus back to growth.

Dan Perlin

You know as I was listening to you talk about that, I was just trying to hearken back a little bit to, like was it 2016 when you kind of went through some of this transition before. And I was thinking is this time more about growth and optimization? And last time it felt like it kind of broke the growth algorithm a little bit. Is that …?

Karen McLoughlin

Yes. So I think -- we had announced, as you said, a change to the margin profile of the company back in February of 2017. And I think there we were trying to strive for a balance of revenue growth and margin at the same time, margin expansion. Certainly the market has shifted a lot since that period. And I think some of the transition to digital has happened even faster than perhaps we might have expected. That's not a bad thing. It just obviously creates opportunities in a different way.

And then I think as we said, there was quite a bit of disruption or distraction in the company over the past year or so before Brian joined. So I think this time it really is about the primary focus being on growth. But then -- that the knowledge that you’ve to in order to grow and frankly secure business in this environment you have to have a cost structure that allows you to be competitive in the marketplace.

Dan Perlin

Right. Right. Okay. And can we talk a little bit about this -- it's kind of like a two-part strategy, so to speak, that you're rolling out when you've talked about protecting and optimizing kind of the core portfolio. And then on the other hand you really need to be expanding and winning in these key digital battlegrounds of which you talked about four, which we can we can go into. I just wanted to know at a high level how you're -- how you’re kind of, presenting that idea, not only internally, but as you think about presenting it to the Street?

Karen McLoughlin

Yes. So I think from an internal perspective, this is something we've talked about for many years. And the notion -- and it's not just now, this has really been the history of Cognizant that we've written these technology waves. And as you're riding each technology wave, right, you have to be investing in the new and protecting the old so to speak. The interesting thing now is that still the vast majority of our revenue comes from more, what you might call more traditional technology services. But those services are critical to our success, not only because in many cases they continue to grow and they are very nice margin businesses and drive a lot of cash-generation for us, but they're also the real foundation of our relationship with our clients. And so the knowledge and the relationships we have with our clients in the more traditional outsourcing business really allows us then to expand into the more digital transformation side of the equation with the client. And so we really believe that those two go hand-in-hand and will be what drives a lot of the success over time. Now how we manage those two sides of the business is different and we will be different in the future. Clearly, you're driving the scale businesses to be more mature -- as more mature businesses, right? You need less investment. You need to really optimize your cost structure, you have to remain very competitive there. And then on the more transformative newer digital sides of the business, it's really about how do you continue to invest for growth.

Dan Perlin

Okay. Now these battlegrounds, data digital engineering and cloud and IoT. So where do you feel like you've got success? And quite frankly, do your clients have to kind of take a step back and get more modernized infrastructure before you can even attack those battlegrounds like are we really able to jump to that if some of those clients aren't ready for it yet?

Karen McLoughlin

Yes, that's a great question. I think clients are trying to do a lot of different things at the same time.

Dan Perlin

Yes.

Karen McLoughlin

And I think really depending on where our client is in their maturity, you might be right. There may be they may need to sort of modernize their core infrastructure before they can …

Dan Perlin

Which you can help with. So that’s …

Karen McLoughlin

… move forward, which we can help with. We are a full service provider.

Dan Perlin

That’s exactly right.

Karen McLoughlin

And very happy to be that. I think what we tend to see is we tend to see clients tackling multiple parts of the equation at the same time. When digital started if we go back now probably 9, 10 years and everybody thought that digital was really the front end of how customers engage with their consumers and more of the marketing spend. Everybody talked about the technology spend shifting to the Chief Marketing Officer. Now what you see is really digital is across the enterprise. And so you see clients embarking on multiple initiatives really across the spectrum of the work that they have to get done.

I think the four initiatives that we've been talking about lately are certainly not the only four things that we will do in digital, and that we do today, but they are going to be the primary focus of our investments in the near-term. And if I sort of just run through the four quickly, so data and analytics, I mean that is really core to Cognizant's heritage, right? As a former Dun & Bradstreet subsidiary that really is how we were formed and so we've always had a very strong analytics practice. And so that comes very naturally to us as a place to operate.

Digital engineering has been a big focus for us in the last couple of years. We've done a couple of acquisitions, including the Softvision acquisition about a year-ago, which gives us a very strong footprint in the digital engineering space. It's a little bit of a different model in terms of the delivery structure. And the fact that you have a big Eastern European footprint. And so that was one of the great things that Softvision bought to us as well as a very strong methodology and how to deliver digital engineering projects at scale for clients. So that's been a great acquisition that we will continue to build and back off.

Dan Perlin

I don't mean to interrupt, but is that helpful in terms of being competitive with EPAM, Luxoft and …

Karen McLoughlin

Absolutely.

Dan Perlin

… all those guys? Was that, like, something you felt like you needed?

Karen McLoughlin

I think it was a nice supplement to the -- to what we already had. So internally we have about 11,000 people today that make up our digital engineering practice.

Dan Perlin

Okay. So that’s a sizable practice.

Karen McLoughlin

So it is a very sizable practice, but the Softvision acquisition really sort of gave us that grounding in the methodology and frameworks as to how to really do it effectively.

Dan Perlin

Okay.

Karen McLoughlin

So that's been a great addition for us. Cloud, every -- almost everybody is playing in cloud. Certainly and I think the cloud migration is a -- just a very big marketplace. Lots of room for lots of competitors. And I think if you look at the big cloud providers they are all actively seeking partners who can be the services providers to help clients migrate to the cloud. So that will continue to be a big opportunity.

Dan Perlin

Where are we in that cycle? I mean, it seems everybody talked about it for a long time, but it doesn't feel like we're still anywhere near.

Karen McLoughlin

I think we're very early. And it's -- on the one hand, I think we're very early in the cycle. On the other hand, I would actually say it's moved faster than certainly I might have expected a few years ago. A few years ago when we started talking about cloud and particularly our client-base or a client basis, large global 2,000 Fortune 500 type companies. And there was a lot of dialogue about will they go to the cloud? Will they not go to the cloud? Will they just put some peripheral things in the cloud? Is it public? Is it private? I think what you've seen over the last really two years or so as most companies now are very comfortable saying, yes, I'm on a cloud migration journey. And the question is then how fast can they move, and how do they do that? So I think there's lots of opportunity there in the coming years. And then the fourth area that we've been talking about recently which is the newer space for us is IoT. And that is one that really started to get a lot more focused frankly when Brian came onboard partially because of his background. But we also as we were looking at the markets and we looked at IoT, its again another opportunity -- market opportunity that is very, very significant. Early stages in that market and when we looked across the landscape, we said what there really aren't a lot of competitors in that space who have really been able to stake a claim in a meaningful way yet. We have some nice capabilities to build upon several years ago. We had taken over captive from advances and that really created sort of the foundation of our IoT business. And then more recently with the Zenith acquisition that we did just a few months ago, which is focused on IoT in the life sciences manufacturing space. Those give us very nice footprints to really now build upon that business moving forward.

Dan Perlin

That's great. So then let's talk about this 2020 Fit for Growth, right? I mean this is kind of the plan here. How does that growth plan ultimately enable these kind of two -- just two-part strategy as you lay that out.

Karen McLoughlin

Yes. So really it's about how do we ensure that we are structured for success. And it is -- I mean, there's multiple things happening at the same time. But it's about how do we invest in the sales team. So we've talked about hiring an additional 500 sales and sales support folks. That hiring is underway. When we had our earnings release a few weeks ago, we had already on-boarded about 60 of the 500 more are already on board now and we'll continue that hiring for the next couple of quarters. We want to be thoughtful. It's one thing to say you're going to go out and hire 500 people. It's another thing to say you're going to hire them and make them successful. So we're bringing them in waves.

Dan Perlin

Okay.

Karen McLoughlin

So that we can make sure that we integrate them effectively.

Dan Perlin

And what is the expectation as you bring them on -- for them to be producers.

Karen McLoughlin

So from a modeling perspective, we've assumed it takes about 9 to 12 months before they start generating revenue.

Dan Perlin

Okay.

Karen McLoughlin

And then it's probably -- you're probably at the end of the second year by the time they are really at full ramp and making their quotas. If they can do better than that, that's great. But the reality is it takes time to build relationships, build your portfolio and really begins transition work. So this is a multiyear investment that we're making to drive that growth, but …

Dan Perlin

Are they from competitors?

Karen McLoughlin

So some of …

Dan Perlin

I don’t mean to harp, but the point is when you start to attach revenue to hiring, you want to make sure you understand …

Karen McLoughlin

Sure. So many of them come from the marketplace. Others come from other industries and so forth and so.

Dan Perlin

Yes. So these are deeply rooted relationship people?

Karen McLoughlin

Absolutely.

Dan Perlin

Okay. That’s what I was trying to get at, okay?

Karen McLoughlin

Yes. Because this is a relationship business at the end of the day. So that's very important to be able to bring those books where you can with you.

Dan Perlin

Okay. That’s great.

Karen McLoughlin

And so that's one side of the equation. And along with that it's not just about hiring 500 sales people, but it's about making sure that we have enough feet on the street across the company and that our teams, the existing teams as well really understand what it is to drive digital transformation and to be able to get out in front of the client and have the right conversations and sell digital. What’s interesting is we have always been known for client-centricity, right? And we're very fortunate. We have a great client base and our clients tend to love us. They think we haven't maybe in the most recent quarters always been as proactive as perhaps we could have been and used to be. And so this is really about getting our teams to feel confident being out in the market again and showing up and knowing that people like Brian or business leaders or myself will be there to support them and we'll go join them in a meeting if they need to and really help them build the relationships that they need. So we're all out there trying to spend a lot of time in the marketplace in front of clients. I think there's barely a day goes by that that Brian started the client meeting somewhere. And so really setting -- showing everybody what this looks like and what good looks like going forward. So that's a big part of it. And then the other side of the equation is then looking at the cost structure, how do we think about this, how do we make sure that we have in place true operational excellence and operational discipline. Obviously, we don't want to get into a situation where you're constantly having to cut resources and leading to a death by 1,000 cuts type scenario. So we want to do this once, we want to do it quickly, we want to right-size the structure appropriately and then really get back to letting the teams run their business, given the tools, given the metrics they need to run their business and then hold them accountable for executing against that.

Dan Perlin

Yes. Now some of those numbers are pretty big, right? So 10,000 to 12,000 employees you’re kind of retargeting 5,000 for re-skilling. So can you just talk a little bit about how you plan on not I guess running interference so that's not disruptive to the actual process. Because sometimes those to your point are disruptive internally and they can hurt growth.

Karen McLoughlin

Yes. So if we say let's call 10,000 to 12, 000 you said we say half, we were going to reskill and have exit the company. Certainly on the re-skilling. We think that's a real benefit to our associates. So looking now to try and identify who are the first wave of folks that we will put through those re-skilling programs and then put them back into the market. All of this is targeted, and I would call sort of the more mid- to senior levels of the organization. So really trying to address our pyramid. And so how can we either optimize our pyramid through perhaps reducing headcount which will be some of this or then taking remaining parts of the top end of the pyramid and making people billable, right, at market rates right and really driving up the utilization and the growth opportunities for those folks there. On the cost optimization side, it will come through some roll elimination, some performance management. We have just as I think most people know consolidated all of global delivery under Pradeep Shilige. One of the things that does versus allows us to collect some of the smaller business units and really look at the overhead layers of our business and look for opportunities to optimize their as similarly across the other business and across the corporate function. So this is obviously not trying to target billable people. This is not targeting our top performers. And if you think about, let's say it's 6,000 people across the company. By the time you include all of our headcount and some subcontractors you're looking at 2% of the population. So …

Dan Perlin

Yes. Yes. But it is mid to senior type of individuals which suggest that maybe people stayed in their seat too long? So I don’t know.

Karen McLoughlin

Yes. If you think about the history of the company, right. Phenomenal growth for many, many, many, years. And because of that growth we never had to have an upper out policy. We were very fortunate. And so if you look at our pyramid and we've known this for some time. Our pyramid does tend to be more top heavy. They were very good reasons for that. In many cases we have certainly always had a heavier onsite ratio than many of our competitors. We had a more top-heavy pyramid somewhat by design to allow us to grow faster than the market for many years. But it has reached a point where there is an opportunity to create some room for the next round of talent to grow in the company.

Dan Perlin

Okay. Now there's a lot going on with all these transitions. So one of the things you guys also talk about is reinvestment back into the company. And so I'm just trying to understand and put some context around how all of these initiatives are actually going to ultimately enable you to do this level of reinvestment and what that really looks like in terms of absolute dollars?

Karen McLoughlin

Sure. What we've said for next year is focus on 2020 at this point right, is there is a couple of things we need to do. So first and foremost this year because the performance is not where we needed to be, our variable comp accruals are lower than target this year. And so as we go into next year and we set targets for everybody, the presumption is that we will have a plan that allows people to make their variable comp targets. That's roughly a 120 basis points of margin impact to replenish the variable comp pool. So if we think about this year and we've guided to 16.5% to 17% margin on a full-year basis, let's call it 16.7. Let's say we land in the middle of the range. You say a 120 basis points to replenish the comp pools that takes you down to 15.5% normalized margin. Then on top of that we're going to spend another couple of $100 million bringing in the sales teams, we're going to ramp up some marketing, some branding, some -- the rescaling programs we've been talking about, right. So those will be the major investments we make for next year.

Dan Perlin

Okay.

Karen McLoughlin

And then that will be offset by the benefits of partial year benefits of the cost optimization program that we get. So that would take you back. We've guided to a range of 16 to 17, so let's say you're in the middle of the range at 16.5%. So on an annualized basis we said when we're done with the cost transformation program that would get us $500 million to $550 million of cost savings. We would expect to get, let's call it roughly 400 of that next year.

Dan Perlin

Okay. So a big chunk of that.

Karen McLoughlin

Yes.

Dan Perlin

Is the 16% to 17%, I mean is that the right number to run at? Do you think are -- I mean the balance has always been like balance for growth. The growth algorithm relative to the margin components to that, and so I'm just wondering how you -- maybe that's a premature question to ask right now, but just wondering as you think about what this company looks like in the kind of fit-for-growth mentality, the 16% to 17% like a comfortable place for us to be thinking.

Karen McLoughlin

So I think it's early to talk about longer-term margin guidance beyond next year. But certainly the questions we are asking and we'll continue to ask ourselves is: one is, what's the market opportunity. We continue to believe we're in a very strong market with significant upside potential. And so first and foremost we want to make sure that we are investing to take advantage of that to get back to at least market, if not market leading growth rates. Question in our mind is we are hiring 500 sales people now, should that be a 1,000, should it be 800, I think we will determine that as we move further into the cycle and see how they’re performing.

Dan Perlin

Okay.

Karen McLoughlin

And then what other investments, we want to make, right.. So whether it'd be organic investments or inorganic investments to help drive that growth. And so as we get further into next year, we'll evaluate what we think the longer term structure should look like -- certainly as we lap some of this year and as we get the variable comp back in place and we really start to drive the benefits of the savings, all else being equal, that would give you some capacity. The question will be how fast do you want to invest in growth?

Dan Perlin

Yes. As it turns out, people are pretty motivated by money?

Karen McLoughlin

People are very motivated by -- and growth really [multiple speakers] money …

Dan Perlin

So hopefully that'll work. So let's take a step back a little bit and talk about -- because much of what we've discussed is really how you're effectuating all of these changes. Some of that -- most of that’s in your control. The question is what's kind of out of your control. So when we look at the demand environment across the big segments, financial services, healthcare products and then CMT, can we just start with financial services and kind of work our self around in terms of what you're seeing today? And maybe what some of those expectations are going to be over the course of next year?

Karen McLoughlin

Sure. So I think as we look at next year, clients are right now in their budget cycles. So it's a little early to say exactly how that pans out. Although I think and we said this on the call, we haven't really seen any significant shift in the macro environment. I mean there's certainly caution in the market and lots of news in the marketplace and so forth. But in terms of real client behaviors we haven't seen a lot of change at this point, little bit of caution in the U.K. around some of the Brexit news. But that hasn't really filtrated beyond that market. So I think right now in banking, it's been fairly steady. We just hire our new banking leader Dan Cohen, joined us in October. So we'll give Dan a few weeks to figure out his plans and where he wants to take the business. But at this point, no real no real shifts there. Insurance for us has been a very good performer. Historically for the last several years had a little bit of a slower growth this year. We saw a little bit of pickup in Q3, although I think that was a little bit of project-based work. So Q4 is a little bit sluggish again. I think what we saw in insurance this year was just an unusual amount of executive transitions in insurance and that was everything from CEOs to CIOs and in between. And so you do tend to see a little bit of a pullback when that happens as clients rethink their plans and build relationships and so forth. So we'll see how that pans out. But that was -- a little bit unique to the insurance industry this year. Healthcare, obviously, we've been talking about healthcare a lot this year because that was the big, the big dragger, in particular, as a result of the mergers and acquisitions, the two big mergers we saw in the healthcare space. The impact of those contract renegotiations did cost us roughly a $100 million of revenue this year. I didn't material impact on that business. Again there we have a new leader. Jeff joined us just over the summer. And so is really looking at how he gets that business back on track for growth trajectory. We will start to lap the impact of those contract renegotiations as we get into Q2 of next year.

Dan Perlin

Okay.

Karen McLoughlin

And so that will give a little bit of relief, but we continue to believe that the healthcare market is a -- again, very big market opportunity, lots of work to be done there, lots of transformation work in addition to integration work with the mergers and so forth. So again, continued long-term opportunity there. Life sciences for us is continued to be a very strong practice this year. We have a terrific team in our Life Sciences practice. We did undergo an executive transition there, but we backfilled with an internal candidate who has done a tremendous job of keeping the business growing. We've got a great footprint in most of the big pharma companies around the world and doing some very interesting work in clinical trials and elsewhere. And then now most recently with the Zenith acquisition that will open up the manufacturing side of that business for us. So very excited about the opportunities we continue to see there. Products and resources, also another business that has been growing double-digits for us this year. And we've seen good growth both manufacturing and particularly through our manufacturing and logistics business. And then the rest of that business is our revenue -- retail consumer goods and travel and hospitality. So it will be interesting Q4. So typically Q4 for the retailers has historically been a slow quarter for us. You tend to see retailers stop doing development work before the holiday season. Last year it was very unusual though, last year was such a strong holiday season, and in fact our retail business had a terrific fourth quarter and particularly driven by the amount of work they're doing around e-commerce. And really keeping the lights on for a lot of clients. So we think this Q4 might be a little bit slower growth partially because you're lapping tough comps. And also it will be sort of dependent upon the holiday season. So that will be a bit of a question mark as the next couple of weeks kicks in here.

Dan Perlin

That’s good to know. And then CMT?

Karen McLoughlin

Yes. So then CMT again, another great growth business, particularly we’ve seen very good growth on the tech side of the business over the last several quarters, a little bit slower on the communications and media side. I will say the one change that we will see in the CMT business is we are exiting some of our content work as we talked about on our last call and that will all impact the tech practice. So we’ve estimated that the work that will go away is about $240 million to $270 million of annualized revenue. We will see a little bit of that in Q4 and that was baked into our guidance. I think we'll see a little bit more in the early part of Q1 and then we expect although it's still a bit of a question that much of the work will go away towards the end of Q1 early Q2, there will be some that spills over. But obviously, as we have more color, we'll provide updates as appropriate.

Dan Perlin

Okay. One of the other questions we get a lot for our university is durability and business models potentially in the face of recession. So maybe you could just spend the last few seconds here, if you could tell us a little bit about that?

Karen McLoughlin

Sure. It's interesting. So this business has historically been quite strong through recessions. Obviously, it's been a long time since we had one. In prior recessions what used to happen was clients would tend to pull back on what we used to call discretionary spending, but they would accelerate on the outsourcing and off-shoring and anything they could do to drive savings into their business. I think if and when the next recession happens, I think we might see a little bit of a different playbook this time. I think there will be certainly clients who are looking to outsource more and offshore more and do more with a lower pyramid and drive more automation and get the typical run the business cost savings that we've been able to deliver. The question in this time is, what happens to the digital transformation work. And I think obviously we don't know for sure, but there's certainly a thesis to be made that says that work so is mission-critical now to our clients that a lot of it will get protected. And much of the digital today as CEO mandates, it's not just a CIO project anymore. So I think it remains to be seen certainly. But they’re certainly an argument to be made that what will be a different type of environment at this time during the next recession.

Dan Perlin

We hope.

Karen McLoughlin

We hope.

Karen McLoughlin

We certainly hope.

Dan Perlin

I think we are out of time. But Karen thank you so much for being here.

Question-and-Answer Session

[No formal Q&A for this event]

A -

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