Cognizant Technology Solutions Corporation (NASDAQ:CTSH) Q4 2023 Earnings Call Transcript

Cognizant Technology Solutions Corporation (NASDAQ:CTSH) Q4 2023 Earnings Call Transcript February 6, 2024

Cognizant Technology Solutions Corporation beats earnings expectations. Reported EPS is $1.11, expectations were $1.04. CTSH isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Ladies and gentlemen, welcome to the Cognizant Technology Solutions Fourth Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I would now like to turn the conference over to Mr. Tyler Scott, Vice President of Investor Relations. Please go ahead, sir.

Tyler Scott: Thank you, operator, and good afternoon, everyone. By now, you should have received a copy of the earnings release and the investor supplement for the company’s fourth quarter and full year 2023 results. If you have not, copies are available on our website, cognizant.com. The speakers we have on today’s call are Ravi Kumar, Chief Executive Officer; and Jatin Dalal, Chief Financial Officer. Before we begin, I would like to remind you that some of the comments made on today’s call and some of the responses to your questions may contain forward-looking statements. These statements are subject to the risks and uncertainties as described in the company’s earnings release and other filings with the SEC. Additionally, during our call today, we will reference certain non-GAAP financial measures that we believe provide useful information for our investors.

Reconciliations of non-GAAP financial measures, where appropriate to the corresponding GAAP measures can be found in the company’s earnings release and other filings with the SEC. With that, I’d now like to turn the call over to Ravi. Please go ahead.

Ravi Kumar: Thank you, Tyler, and good afternoon, everyone. Today, I would like to cover three topics. Cognizant’s fourth quarter and full year results, an assessment of our progress in 2023, and a look ahead to our focus and outlook for 2024. I’ve been in the CEO role now for a full year and have used this 12 months to dig into the company’s client relationships, operations, services portfolio, market environment, finances and culture. I’ve met with about 400 clients and established a regular cadence of listening to and speaking with our employees across the world. My full year immersion into everything, Cognizant has confirmed my belief in the high level of initiative and motivation of nearly 350,000 employees as well as my belief in the company’s distinctive core strengths.

I have confidence in our potential to increase our revenue growth, and I’ll have more to say about this in a few minutes. Let’s start with the fourth quarter where we delivered on our commitments while continuing to implement our cost management program. To call out three highlights. First, we executed well, delivering revenue within our guidance range despite ongoing macroeconomic pressures and meaningfully exceeded our adjusted operating margin expectations. Second, we made further progress on our goal to increase the percentage of large deals, new clients and business in the overall mix. And third, we saw continued improvement in our voluntary attrition. Q4 revenue of $4.8 billion was in line with the guidance range we provided last quarter.

Year-over-year, Q4 revenue was down 1.7% as reported or down 2.4% in constant currency. The quarter developed much as we expected as clients remain cautious and limited the discretionary spending. Our Q4 adjusted operating margin of 16.1% was meaningfully stronger than we anticipated, driven by savings from our next-gen cost management program and better execution on our operational efficiencies. We sustained our large deal momentum in the quarter, winning seven deals exceeding $100 million each. Of these seven deals, two were new business and five were a mix of renewals and expansions. I am especially pleased to see our continued decline in employee attrition, trailing 12-month voluntary attrition for our tech services business declined to 13.8%, that is down 2.4 percentage points sequentially and down 12 points year-over-year.

Turning to the full year. Revenue of $19.4 billion was down slightly from the prior year and in line with the guidance we set on our Q3 call. A strong Q4 margin performance enabled us to achieve a full year adjusted operating margin of 15.1% compared with a guidance of approximately 14.7%. We ended Q4 with a trailing 12 months booking growth of $26.3 billion, up 9% year-over-year, resulting in a book-to-bill of 1.4x. For 2023, about 30% of our TCV exceeded 50 billion plus deals, compared with approximately 20% in the previous year. We signed 17 deals that exceeded $100 million TCV, $100 million TCV. Total TCV for deals above $100 million increased 42% year-over-year. Several factors contributed to this progress. We have reoriented our teams to large deal demand generation and execution across all service lines.

We have strengthened our ability to seed (ph), shape and sell large deals. And we have made progress in industrializing delivery with automation and productivity tools to create repeatable solutions and enable a consistent and efficient delivery operating model for large deals. Turning to our business segments where Jatin will cover our financial performance, I want to comment on our two largest segments. In financial services, while responding to a demand environment that remains challenging. We are increasing our efforts to stimulate growth. We’ve installed new leaders in a number of key positions across the segment. We have invested in consulting and commercial resources and targets of industries and in partner relationships. We are also focused on expanding our service offerings and on enhancing our industry solutions powered by new technologies like Generative AI.

In Health Sciences, as the healthcare industry continues to undergo major transformation, we believe Cognizant is well positioned to become the nucleus of an emerging healthcare ecosystem through our platform’s data and solutions. With these dynamics in mind, we are investing in the expansion of our TriZetto platform and our healthcare BPaaS solution capabilities. We are also capitalizing on the opportunity Gen AI presents to the healthcare market. For instance, LLM can be used to streamline payer administrative processes, automate clinical documentation and enhance clinical decision support systems. I remain confident in the value of our health sciences portfolio provides to clients. For example, Fortrea recently chose Cognizant as its technology transformation partner to deploy a modern secure digital ecosystem to help bring treatments to patients faster while strengthening its position in the life sciences industry.

And Takeda, a global biopharma company with whom we have had a long relationship has selected us to help modernize their infrastructure and application management in support of the digital transformation. Now let’s turn to an assessment of how we move the company forward in 2023. To begin, we made considerable progress enhancing three core strengths that taken together, I believe, Cognizant set apart in the market. First, industry expertise. In 2023, we further deepened our expertise at the intersection of technology and industry use cases to deliver industry specific solutions in service of business outcomes. We also enhanced our collaboration and co-creation with clients and the broader partner ecosystem to stitch together industry-leading capabilities.

A good example is our strategic partnership with ServiceNow to advance the adoption of AI-driven automation across industries. We are also collaborating with ServiceNow to enhance Cognizant’s WorkNEXT modern workplace services solution with generative AI capabilities. WorkNEXT aims to provide more intuitive and personalized experiences for employees, while helping to better quantify and improve the return on experience for enterprise customers. A second core strength we are collaborative partners to our clients. As mentioned on our Q3 call, our annual client Net Promoter Score survey hit a historic high for Cognizant last year. Our empathy for clients as a part of our DNA and we believe we have become even better at listening carefully to, learning from, and working with clients to earn their trust, solve their problems and help them succeed.

Third, we are passionate innovators. Last April, we launched Cognizant’s Bluebolt grassroots innovation program calling on all our employees to help us solve client problems, look for unmet or latent client needs and challenge the status quo. And in just nine months, our employees generated more than 100,000 ideas, 21,000 of which we have already implemented. We expect to augment our Bluebolt program through a new collaboration with Microsoft to launch the innovation assistant as generative AI-powered tool built on Azure OpenAI service. Shortly after my arrival, we consolidated our performance objectives, the way we measure success. But just three long strategic priorities, long-term strategic priorities. Become the employer of choice in our industry, accelerate revenue growth and simplify our operations.

I’ll touch on our progress beginning with employer of choice. Our voluntary attrition improved throughout 2023 to multi-year lows, while our employee engagement scores improved to capitalize Cognizant’s entrepreneurial spirit, we have given greater autonomy and accountability to business unit leaders. This is helping increase our responsiveness to client needs and market conditions. We remain committed to providing our teams with continuous learning, upskilling and professional development. In 2023, 90% of our global workforce spent time in learning with 270,000 of our employees acquiring at least one new skill proficiency. And 88,000 completing AI and generative AI courses. We’ve also established programs provide more opportunities for employees to advance their cadence.

I’m pleased to say, we promoted nearly 30,000 people across the company last year. Later this month, we’ll bring together our entire employee population and gatherings, physical and virtual to recognize excellence across the business with Cognizant’s companywide awards program the IMPACT Awards. Late last year, we introduced an initiative called Shakti that will unify our women-centric programs to further advance carriers and boost women leadership in technology. Shakti will encompass Cognizant’s leadership development programs for our senior level women globally and for our mid-level women in India along with our period upskilling program for women returning to work after a career break. Our second performance objective is to accelerate revenue growth.

We’ve invested heavily in platform-centric approaches to further differentiate Cognizant in select industries. I’ve talked about our core platform just TriZetto in healthcare, Shared Investigator in life sciences and asset performance in smart manufacturing to name a few. Last year, we also began industrializing solutions for the next wave of technologies with our AI portfolio. We introduced Cognizant Neuro IT Operations, our AI led platform built to reduce the complexity and costs of enterprise infrastructure. We launched Cognizant Skygrade our cloud orchestration platform designed to help clients to rapidly transition to modern cloud-native architectures. In addition, we introduced Cognizant Neuro AI, developed to speed clients’ adoption of generative AI.

With Neuro AI, we are able to quickly build AI enablement use cases for clients that are specific to their businesses. And just last week, we expanded our GenAI portfolio with the introduction of Cognizant Flowsource, developed to help engineering teams, deliver high-quality code faster with increased control and transparency. Today, we have over 250 early engagements that incorporate the use of generative AI. Some examples are creating a virtual coach for a diabetic patient for a pharma company, predicting the size of target audiences for a TV network, conducting sentiment analysis and summarization of user comments for a large bank, developing field services expert advisor for a manufacturer, enabling conversational intelligence for an insurance call center and auto generating a sales pitch for a tech company.

A data analyst using cutting-edge analytics to accurately interpret complex sets of data.A data analyst using cutting-edge analytics to accurately interpret complex sets of data.

A data analyst using cutting-edge analytics to accurately interpret complex sets of data.

We have another 350 plus opportunities in our pipeline that we are planning to scale. We aim to infuse AI, not only into our core offerings but into everything we do, including using generative AI to create industry and functional services. It’s worth mentioning that one of our integrated practices, intuitive operations and automation which helps clients, build and plan modern operations across $2.5 billion of revenue in 2023. Our tech-driven modern BPO and automation services helps clients achieve higher levels of productivity and reap benefits of generative AI in the core processes. We strive to stay tuned to market shifts, which is why last month, we acquired Thirdera. And Elite ServiceNow Partner that specializes in solutions for the ServiceNow platform.

Adding Thirdera brings an on and near-shore global presence to our own ServiceNow Business Group. With Thirdera, we’ll continue to advance the efforts of our strategic partnership with ServiceNow to build a $1 billion combined business focused on AI driven automation. Our third performance objective is to simplify our business. We executed well on our NextGen program, which is aimed at simplifying our operating model, optimizing corporate functions and consolidating and realigning workspace to reflect the post pandemic work environment. Our cost management enabled us to achieve a 2023 adjusted operating margin performance that exceeded our expectations from early in the year. Simplifying our business goes beyond structurally reducing costs.

It also helps us become more agile and productive and innovative. Last year, we further streamlined our operating model and what we — what was a complex metrics structure to focus primarily on our markets and integrated service lines. We are moving towards fewer layers in the organization, which we believe will bring us closer to our clients and associates, help drive strong coordination across the company and further empower account teams to make decisions. In summary, 2023 was a year of strengthening our company’s fundamentals. Now let’s look at — look to our focus in 2024. We have selected six strategic imperatives that will help further sharpen our differentiation across clients’ primary needs, while strengthening our ability to achieve our performance objectives.

These imperatives are to grow in select industries, expand internationally, with large deals capabilities, capture the AI opportunity, deliver our talent strategy, and implement our IT roadmap. In the interest of time, I’ll focus on only one of those initiatives which is capturing the substantial AI opportunity. Although, consumer use of generative AI is starting to explore, enterprise use cases have been ramping slowly. That said, we expect the pace of enterprise adoption to pick up soon and believe that after a slow takeoff movement of this curve will accelerate sharply. The results we have seen from initial GenAI proof-of-concepts are very encouraging. We believe system integrators like Cognizant will play a major role in managing, governing and optimizing generative AI initiatives upscale.

This includes building accuracy in output, reducing hallucinations continued reenforced learning and testing incorporate — incorporating transparency and accountability and iteratively driving performance optimization. Therefore on — as mentioned on our prior calls, we expect to invest approximately $1 billion in our generative AI capabilities over the next three years, spanning people, platforms, partnerships and M&A. We believe generative AI is becoming a driving force for the economy and society. In partnership with Oxford Economics, Cognizant developed and published a new economic impact study end of last month’s World Economic Forum that predicts, generative AI could inject up to $1 trillion into the U.S. economy over 10 years. Our research also predicts that 90% of the jobs will be disrupted in some way by this technology.

From 2023 to 2032 the percent of jobs with high exposure scores, meaning the degree to which an occupation will be affected by generative AI could increase from 8% (ph) to 52%. Setting the stage for a profound shift in how we approach work, productivity and economic growth. One last topic to cover and that’s the demand environment. We see little change from the assessment we have provided in recent quarters about uncertain and weak discretionary spending in the early part of 2024. Given that clients are experiencing a period that has brought both change and uncertainty together, we expect them to continue to focus on reducing costs, consolidating vendors, modernizing the data and the processes and increasing the productivity, so that they can imply savings to AI led transformation.

On a closing note, we celebrated our 30th anniversary just last month. We have stood the test of time and we are determined to sustain and extend the momentum we’ve created last year. As optimistic as I was about our company’s future, when I joined last January, I’m doubly so now. Whatever the future may hold, I believe we are in a significantly strong position today than we were one year ago to seize the market opportunity ahead. Now it’s my pleasure to turn the call over to Jatin, who joined us on December 4th for his initial observations about Cognizant and additional details on the quarter.

Jatin Dalal: Thank you, Ravi and good afternoon everyone. I am very excited to join Cognizant, and would like to thank the entire organization for such a warm welcome. I would also like to thank, Jan, for helping me in making the onboarding experience so seamless. I have always admired Cognizant’s growth mindset, client centricity and the entrepreneurial culture. While it has only been two months since I joined, the energy and passion across the organization are apparent. I have also had the opportunity to participate in our global sales kickoff events in January. This has further strengthened my conviction in Cognizant’s capability and our market opportunity. I’m excited to partner with Ravi and the entire leadership team, to build on the progress we have made in 2023, as we strive to reach our full growth potential.

In doing so, I believe there is a tremendous opportunity, to create long term sustainable value for our associates, clients and shareholders. With that, let’s turn to our fourth quarter and full year revenue results. Fourth quarter revenue was $4.8 billion, representing a decline of 1.7% year-over-year or a decline of 2.4% in constant currency. Year-over-year performance includes approximately 90 basis points of growth from our acquisitions. This led to full year revenue of $19.4 billion, which declined 0.4% year-over-year or 0.3% in constant currency. Year-over-year growth includes approximately 110 basis points of growth from acquisitions. Ravi discussed Financial Services and Health Services, which declined 6.6% and 2.7% year-over-year in constant currency, respectively.

So I will quickly comment on our other two segments. Products and Resources revenue was roughly flat year-over-year in constant currency, which included contribution from recently completed acquisitions and the ramp of new business. This helped offset the macro-driven discretionary spending pressure. We saw relatively better performance in North America, particularly among auto, utility and travel and hospitality clients. Communication, media and technology revenue increased 2% in constant currency. The growth reflected the benefit from recently completed acquisitions and the ramp of new bookings. Now, moving on to margins. During the quarter, we incurred approximately $40 million of costs related to our NextGen program. This negatively impacted our GAAP operating margin by approximately 90 basis points.

Excluding this impact, adjusted operating margin was 16.1%. Year-over-year, margin included savings from our NextGen program and tailwinds from the depreciation of the Indian rupee. This helped partially offset increased compensation costs. As a reminder, the prior year period also included a negative impact from a noncash impairment charge, related to a Health Sciences customer. Our GAAP tax rate in the quarter was 26%, adjusted tax rate in the quarter was 25.4%. Q4 diluted GAAP EPS was 1.11, which is $1.11 and Q4 adjusted EPS was $1.18. Now, we turn to the balance sheet. We ended the quarter with cash and short term investments of $2.6 billion or net cash of $2 billion. DSO of 77 days was flat sequentially and increased three days year-over-year, driven by our business mix.

Free cash flow in Q4 was $659 million which brings full year 2023 free cash flow to $2 billion or approximately 95% of the net income. This was slightly ahead of our expectations. During the quarter, we repurchased over 4 million shares for $313 million and returned $146 million to shareholders through our regular dividend. For the full year, we returned about $1.7 billion to shareholders, including $1.1 billion through share repurchases and $591 million through our regular dividend. As of December 31, we had $1.8 billion remaining under our share repurchase authorization. Turning to our forward outlook. For the first quarter, we expect revenue in the range of $4.68 billion to $4.76 billion, representing a year-over-year decline of 2.7% to 1.2% or a decline of 3% to 1.5% in constant currency.

Our guidance assumes currency will have a positive impact of approximately 30 basis points. For the full year, we expect revenue to be in the range of $19 billion to $19.8 billion, which is a decline of 1.8% to growth of 2.2% year-over-year or a decline of 2% to growth of 2% in constant currency. Inorganic contribution is expected to be up to 100 basis points, and we anticipate approximately 20 basis points positive impact for the year from the currency. Our NextGen program remained on track this quarter, and we still expect to incur total cost of approximately $300 million. This includes $229 million incurred in 2023, and our expectation for an additional $70 million in 2024. There are no changes to our savings assumption from NextGen, and we still intend to reinvest the majority of the savings in the growth opportunity in 2024 and beyond.

Moving on to adjusted margins. We are pleased with the strong finish to 2023, which allowed us to deliver a full year adjusted operating margin of 15.1% versus our guidance of 14.7%. In 2024, we continue to expect 20 to 40 basis points of operating margin expansion. This represents an adjusted operating margin range of 15.3% to 15.5%. We remain focused on driving further efficiency in our business model through improved utilization, increased operational discipline and automation of tools and processes. We are also introducing guidance for net interest income versus our prior practice of providing gross interest income. For the full year, we anticipate net interest income of approximately $40 million. Our expectation for the full year adjusted tax rate is 24% to 25%.

For the full year, we expect free cash flow will represent about 80% of net income. This includes an anticipated negative impact of approximately $360 million because of a ruling on January 8 in India relating to a previously disclosed 2016 tax matter in connection with share repurchase transactions, undertaken by our Indian subsidiary. The ruling required Cognizant to deposit the funds with India tax authorities to proceed with our appeals process. The funds deposited with tax authority were previously held in bank deposit under lien. And as of December 31 were presented on our balance sheet under long term investments. The outflow will negatively impact our operating cash flow, but will not impact the cash and cash equivalent amounts on the balance sheet, and therefore, we do not anticipate any impact to our capital allocation priorities.

Final amounts refunded to Cognizant or due toward tax authorities will be determined at the end of the appeals process. We continue to believe that we have complied with all tax regulations applicable to this matter in accordance with the law and intend to vigorously defend our position. Moving on to capital allocation. We expect to return over $1 billion to shareholders in 2024, including at least $400 million through share repurchases and $600 million through regular dividends. We will also continue to pursue acquisition opportunities aligned with our strategy. For the full year, we therefore, expect to deploy more than 100% of free cash flow, given the negative impact of the free cash flow from the aforementioned additional deposit with the India tax authorities.

Based on our anticipated share repurchases, our guidance for shares outstanding is approximately $497 million. This leads to our full year adjusted earnings per share guidance of $4.5 to $4.68. With that, we’ll be open to take the questions.

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