Q2 2019 Earnings Call
Ladies and gentlemen, welcome to the cognizant technology solutions second quarter 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.
If you would like to ask the question at that time. Please press star one on your telephone keypad, a confirmation tone will indicate your line is in the question queue.
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I would now like to turn the conference over to Katy Rice Global head of Investor Relations at Cognizant. Please go ahead.
Thank you Jeremy and good afternoon, everyone.
By now you should have received a copy of the earnings release and the company's second quarter 2019 result.
If you have not a copy is available on our website cognizant dot com.
Interesting had on today's call, our brine Humphrey Chief Executive Officer, and care Mclaughlin 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 FTC.
Additionally, during our call today, we will reference certain non-GAAP financial measures that we believe provide useful information for investors reconciliations of non-GAAP financial measures, where appropriate to escort corresponding GAAP measures can be found in the company's earnings release and other filings with the FCC.
With that I'd now like to turn the call over to Brian Humphrey. Please go ahead Brian .
Thank you Katie and good afternoon, everybody and thanks for joining.
Earlier today, we announced results for second quarter Q2 revenue grew 4.7% year over year in constant currency to 4.14 billion.
non-GAAP EPS was 94 cents.
Well, we are pleased that we met our revenue and margin guidance. We are not satisfied with this level of performance. Our second quarter results do not reflect that cognizant is capable of achieving in this market environment.
Neither on revenue growth nor margin right.
So what we said about correcting these trends I'm convinced that a large part of what we need to do.
He's in the room control.
Softness in banking and financial services, which was up 1.7% year over year in constant currency and health care, which was down 1.5% in constant currency.
Impacted second quarter revenue growth.
Well certainly market dynamics that impacted our results.
I believe that much of a weakness in banking and then the non life Sciences portion of health care is attributable to cognizant specific issues.
Linked directly to clients in both the industry's underlying that they are committed to investing in innovation to help increase their competitiveness and growth.
Specific to our banking practice, we've recently implemented a new operating model, which includes the team's solely focused on new logos.
A team dedicated to the platinum accounts, which are a subset of our largest global clients.
And the banking practice and solutions team to ensure we develop more compelling for leadership and better align the key partners.
In health care factors, such as any in sourcing at a large healthcare payer clients and the spending pullback by clients that are in the midst of merger integration impacted our performance in the quarter.
Fundamental market changes reshaping healthcare, requiring our clients do more with less and get ahead of regulatory compliance and complexity, well dealing with cyber threats and privacy concerns.
We have a market leading position in health care and the position of considering its considerable strength.
Upon which to build.
I believe industry specialization will be more important than ever with the shift to digital and hence expected be spending a great deal of time at our health care business and clients to ensure we turned around it surprised us it.
Over the past three months, we change that the leaders of both banking and health care to get a fresh perspective, you energy and even greater customer focus.
On a positive note, we delivered double digit growth in products and resources and in communications media and technology.
I continue to be pleased with our momentum in international markets.
Our global growth markets region, which encompasses our non North America operations surpassed the 1 billion run rate for the first time in our history.
We intend to invest in our international business, which should continue to be a growth driver for cognizant.
Later in the call current who will take you through the details of quarter, including segment commentary.
As you know I assumed the role of CEO in April 1st since then I have significantly deepen my knowledge of the company was reviewing the market opportunity structure and competitive dynamics.
Over the last 18 weeks I've met with more than 100 clients and partners across three continents and conducted over 60 deep dives strategic and operational reviews of the company.
I've actively solicit declined input on our strategy and the strength of our commercial and delivery teams.
I've also spent a great deal of time, considering customer needs in buying behavior or brand position our business strategy.
Effectiveness of our organizational structure, our operating discipline.
Our portfolio of solutions, and indeed, our talent and culture.
It is clear to me that cognizant has a proud heritage significant customer loyalty, a broad portfolio of offerings and engaged and talented associates throughout the world.
However, we can position ourselves better to participate in the market opportunity.
And this work includes.
We're finding our strategic posture.
And associated and make leaders to ensure we better participate into categories that are most relevant to our clients needs.
Developing greater thought leadership and an innovation agenda by industry vertical.
Accelerating investments in revenue growth, including increased sales and marketing targeted innovation and enhanced partnerships.
Significantly lowering our cost structure to facilitate these investments in growth.
And to ensure we are most.
More cost competitive in deals.
And ensuring greater operational discipline and a more performance based culture to make certain we execute would rigor and focus.
Our path to accelerated growth starts with customers the life blood of every company.
It is important that we ready ourselves to address the pricing demands of customers in their traditional areas of strength was readying ourselves also for the changing dynamics digital.
Given advances in technology customers, regardless of their industry vertical are faced with an unprecedented pace of change in risk of disruption.
Against this backdrop their focus on modernizing their environments extracting value from data better understanding their own customers and accelerating innovation and cloud migration to increase their competitiveness security and agility.
As investments are shifted to digital budgets in the legacy or pressured with increased focus on cost reduction during renewals.
Given our traditional business mix.
Cognizant has been exposed to this headwind.
We partially offset this be a pyramid management automation and other delivery efficiency leaders.
In addition, given our strong customer NPS, we have often been able to provide incremental savings declines by consolidating to work of other vendors.
Well these strategies need be affected in the short term.
We need to significantly accelerate or shift to digital as we consider our intermediate and longer term future.
The pivot digital requires us to rethink many aspects of the company, including our brands skills processes systems and tools.
Client engagements will become more project oriented meeting more contracts with lower TCV.
Our account teams will need to build.
Relationships with a broader C suite as budget owner's decision makers and influencers to extend well beyond the CIO.
We will need more consultative selling skills more digital talent more targeted sales compensation programs and more intellectual property unfold leadership aligned by industry vertical.
Delivery will be increasing the agile with near an onshore delivery complementing offshore centres.
The skills of our associates and our leadership team must further evolve.
This is a multiyear transition that is essential to our future.
Against this backdrop customers are choosing their strategic partners. So.
As we more readily embrace digital we must ensure our client facing resources under branding represent or strategic ambition.
Meanwhile, we need to be even more deliberate in our solution portfolio, which includes increasing our investments in areas that provide the greatest value declines while generating the best return for cognizant.
This requires a rigorous capital framework to accelerate our position in emerging categories, whilst reducing our cost structure in mature and declining categories.
We have a strong foundation to build from in some of the growth categories. One such example, one I'm extremely excited about is digital engineering.
This is a large attractive market with 20% plus growth rates.
To accelerate our position in this market, we recently decided to combine cognizant digital engineering capabilities with covenants and soft vision.
Until now our assets have been distributed across cognizant and our structure and operating model have been fragmented and inconsistent.
It's combined practice, we delivered 11000 associates and revenue of approximately 800 million will provide a powerful combination of software product development and application modernization services to clients across the globe.
I believe that our focus efforts will ensure greater brand recognition in this important category.
And allow us to do more meaningful more meaningfully participate in the market opportunity.
Our increased focus on digital engineering reflects the market opportunity before us.
And the growing needs from our clients to achieve top line growth improve customer engagement through superior experience and boost productivity at an accelerated pace.
With this combined practice, we will bring together current and emerging technologies scaled cross functional teams and innovate talent and delivery methods into a single product centric operating model.
You're building to digital culture into our operating model that influences our clients conceived design engineer and ship digital products and speed.
At the same time, we're leveraging decades of experience and expertise in our claims technology stack to produce a cloud ready architecture.
We will finalize our strategic positioning in the coming weeks, however, as we enable our customers to disrupt and innovate be a modern scalable agile data enabled and future proof architectures. It is clear that we should further accelerate or investments in digital engineering cloud and I O T.
And we must strengthen our partnerships with industry leaders to buttress our own capabilities.
That being said.
This is not a strategic overhaul, but rather if a refinement of the strategic positioning or capital allocation and the enabler is critical.
To execute our strategy.
Against this strategic backdrop, we need to determine the necessary steps to be taken to unlock cognisance growth potential.
For this reason we have established a transformation office, which is charged with reviewing six areas of focus as follows.
Strategic choices.
Which include where we want to make strategic bets to better expose us to growth categories.
Organizational structure, which includes our operating model, our matrix and roles and responsibilities within this.
Holland, which includes attracting developing and retaining talent our culture.
Our compensation structures and their skills.
Delivery transformation, which includes optimizing our unit cost of delivery across the global delivery model.
Sales force transformation, which includes compensation plans customer segmentation increase partnerships sales coverage ratios and consultative selling.
And finally.
And for growth.
Well James to ensure we have the cost structure processes and tools to facilitate growth.
Each work stream is led by a member of our Executive Committee.
His cross functional in nature and is set against a comprehensive change management and communications framework.
We've made significant progress in a short period of time.
I'm personally excited about his findings of transformation office, which underlines to me that we can meaningfully change our competitiveness in this market.
We've identified opportunities to sharpen our strategic focus simplified the organization.
Clarified roles and responsibilities in power our teams closer to the customer and free up investments in growth by significantly reducing our cost structure.
But we have more work to do in the weeks ahead, including internal change management and communications to maximize associate engagement.
We expect to outline the details of this program, including the execution plan and associated restructuring charges.
On the third quarter earnings call.
Happy customers speed. The first line of the income statement. So as we aim to accelerate our revenue growth I want to lead by example by striving to be in front of customers every single day.
I've asked for greater innovation and growth focus from our executives and have made some changes in the leadership team.
Both external hires and indeed internal promotions.
Meanwhile, to ensure our senior leaders get closer to our customers and our frontline operations, we've initiated a process to optimize our spans and layers.
This has the added benefit of speeding up decision, making improving communication and reducing costs.
Growth also requires investments in sales coverage targeted M&A and a competitive cost structure.
Therefore, even ahead of the execution of the conclusions of the transformation office, we have moved on a number of things including.
The acquisition of <unk> technologies, which expands called lessons IP portfolio and extends our life sciences domain expertise by enabling us to become a single source provider of end to end smart factory capabilities.
A key growth driver in industry 4.0.
The separation of digital systems and technology, one of our three service lines from our delivery organization to increase focus on that service line.
Well its optimizing delivery capabilities.
And.
The approval to hire 500, plus revenue generating associates over the coming quarters accommodation of customer facing and field support professionals will help us expand existing accounts as we generate new ones.
Finally, we need to drive more of a performance culture in our Klein jeans.
Therefore, we will overhaul or sales commission plans for the new fiscal year, ensuring that we can better attract retain and reward top performers.
The new plant will have a greater mix of variable compensation, ensuring greater meritocracy and better align our overall incentives with the company's strategic direction.
The growth mandate is now starting to permeate the entire company informing or big decisions and investments and beginning to reshape the critical behaviors of our employees.
As we focus on growth. We've also made some operational and cost structure decisions the car and will address later in the call.
This will help our cost structure in the second half.
Even ahead of the full conclusions of the transformation office.
Cognizant has a vast organization brimming with talent.
At the time of change we must engage the winning spirit of EUR 290000 associates to get back to the basics that resulted in our long record of success.
Leaders are key and transitions.
For our most talented leaders who were at the director level and above we recently implemented a retention program to let them know have value there.
And how committed we are to their continued career growth with us.
Communication is more important than ever right now.
So in recent months, we've also greatly increased communication to our associates.
We've stressed that growth is our number one priority and provided context, which are what is needed for us to return to growth.
I personally im spending a lot of time meeting with associates reminding them of our tremendous assets and great heritage.
We're building on and a substantial market opportunity in front of us.
Let me wrap up by saying that I now have a much clear understanding of the market opportunity, which is meaningful and cognizance opportunities and challenges against this backdrop.
While we've taken some tactical decisions in the last three months on cost and growth.
The true potential of cognizant and extensive to work to be done on costs and transformation in the quarters ahead.
Is becoming a part and at par and via the transformation office.
The opportunity keyed up from the exit of these work streams gives me reason to be optimistic I see plenty of opportunities to take cost out of the business.
To invest in growth and to improve our working capital.
We will spend more time on this in the third quarter earnings call.
I've covered a lot of grants, let me quickly underscore the five focal points of our work.
We're finding our strategic posture.
Developing greater thought leadership, and an innovation agenda by industry sector.
Accelerating investments in growth.
Significantly lowering our cost structure.
And ensuring greater operational discipline and a more performance based culture.
Well there is a lot of work to be done to ensure a cogs and returns to its historical levels of performance I can assure you that our team is up for the challenge and looking forward to meeting again.
With that.
My pleasure to turn the call over to Caren, who will give you an update on both our operational and financial performance as well as a view on how we see the balance of the year.
Karen.
Thank you, Brian and good afternoon, everyone.
Second quarter revenue of 4.14 billion was at the high end of our guided range and represented growth of 3.4% year over year or 4.7% in constant currency.
Digital revenue growth accelerated from previous quarters to the mid 20% range and now contributes approximately 35% of our total revenue.
Moving to the industry verticals, where overall company performance continues to be impacted by both financial services and health care.
Financial services growth was up 1.7% in constant currency.
Driven by modest improvement in banking, primarily from the contribution of the previously announced partnership with three finished financial institutions to transform and operate a shared core banking platform.
In insurance growth continued to be sluggish as delays in decision, making impacted the startup new work from projects in the pipeline.
We anticipate some improvement in insurance in Q3, but the ramp up of several of these projects.
In banking, we continued to see softness at a few of our largest banking clients and a cautious approach to spend with several of our regional banking clients in North America that were impacted by M&A activity.
Consistent with recent trends two of our top five banking clients continue to show good growth well spend at the other three clients remains under pressure.
We anticipate some cautiousness and overall levels of spend in the banking sector in the second half of the year due to weakness in capital markets across banking M&A activity with you as regional banks and weak macro factors.
Moving on to health care, which declined 1.5% year over year in constant currency.
Within our health care vertical the decline with our payer clients was largely the result of several large clients involved in mergers as well as the accelerated movement of some work to a captive at a large client.
We continue to ramp down of an account in which we were a subcontractor to a third party also continued to negatively impact revenue.
Well the ramp down of the work is largely complete we expect some continued year over year revenue impact in Q3, and a minimal impact in Q4.
For our payer clients moving work to a captive and those involved in mergers we expect the second half of the year to stabilize near Q2 levels.
We continue to expect that there will be meaningful future revenue opportunity associated with integration work that typically follows the merger.
Life Sciences had another quarter of double digit growth year over year, we are seeing good traction for digital operations services, managing Pharmaco Debjit pharmacovigilance cases globally large enterprise transformation deals and momentum with our industry specific platforms, such as the shared investigator portable clinical trials.
And as Brian mentioned, we closed the acquisition of that technology is earlier this week.
Products and resources had another strong quarter, showing 12.3% growth year over year in constant currency.
This is the sixth consecutive quarter of double digit constant currency growth.
We saw continued positive momentum in retail, where we have well above the company average mix of digital revenue in our largest client.
And we continue to see strength in cloud and digital engineering services and increased demand for interactive aiotv and analytic solutions across clients.
Our communications media and technology segment had another strong quarter of year over year growth of 14.1% in constant currency.
Technology saw double digit growth driven primarily by our digital content services and solutions.
Through our acquisition of thoughts Division. We're also seeing good traction for digital engineering solutions with our technology clients.
Within communications and media growth was negatively impacted by spending reductions and a few large clients.
As we move into the second half of the year, we expect to see some slow down in the year over year growth rate if the technology vertical as we start to ramp lapped the significant ramp up of the digital operations work with several large clients.
We expect this to be partially offset by improvement in communications and media.
Now moving onto the geography.
Europe grew 14.2% year over year in constant currency.
In both the UK and Continental Europe , we saw strength in life Sciences, and while a few of our larger banking relationships in Europe remained under pressure.
We did see good growth from several of our newer logos, including the partnership with the three financial finished financial institutions.
Additionally, in the UK, we saw strength in products and resources.
The rest of the world grew 6.4% year over year in constant currency.
Results in Asia Pacific continued to be negatively impacted by the weakness in some of our larger banking clients.
We saw double digit growth with an insurance manufacturing logistics and life sciences clients in the region as well as good traction with winning work with a number of new clients.
Shifting now to margins.
Our GAAP operating margin and diluted EPS were 14.9% and 90 cents respectively.
Adjusted operating margin, which excludes realignment charges was 16.1% and our adjusted diluted EPS was 94 cents in the quarter.
Our adjusted operating margin was in line with our expectations, but down approximately 300 basis points year over year.
Well year over year head count growth slowed from the prior two quarters the year over year decline in operating margin was primarily due to cost related to head count growth of 7%.
Outpacing constant currency revenue growth of 4.7% in the quarter.
And the impact of contract renegotiations with recently merged health care clients, which negatively impacted operating margin by 320 basis points and 40 basis points respectively.
Revenue in head count and digital operations continues to grow above company average and we saw a slight increase in the on site mix at senior levels of the organization.
This was partially offset by lower incentive and stock based compensation.
The lower segment operating margin in our communications media and technology segment reflects the growth of digital content services and solutions in this segment, which generate lower margins and other services in the portfolio.
For the remainder of 2019, we expect margins to improve as we align our cost structure with our revenue expectations.
While we expect to be in a better position to discuss our longer term view of margins in the coming quarters. There are several areas that we can and will address in the second half of the year to allow us to reduce costs to reinvest in areas to drive growth, including attracting and retaining the best talent and expanding our portfolio of digital solutions.
Even ahead of the conclusions of a broader benchmarking exercise in the second quarter, we took targeted actions at the senior levels of our chairman to simplify our organization structure.
These actions are expected to result in $65 million in annualized savings with approximately half of that to be realized in the remainder of 2019.
In Q3, and Q4, we expect to further reduce overall cost.
Through a number of actions including.
Aligning head count growth with revenue growth by further slowing the pace of hiring and being thoughtful on where we backfill attrition.
Headcount growth on a full year basis, well aligned to our full year constant currency revenue guidance.
Of greater discipline on capturing improved pricing levers.
More closely aligning promotions and wage increases with bill rate adjustments.
More rigor around redeploying unbilled resources in our accounts.
And we will continue to optimize our pyramid by adjusting our spans of control.
We will have enhanced oversight regarding our use of subcontractors and the balance between subcontractors and full time associates.
We will also have significantly tighter controls areas within ESS, you nay, such as disciplined hiring of non billable resources.
Further rationalization of our real estate portfolio.
Tighter control over T.N.E., including significantly reduced travel for internal and other non client facing meetings.
Limiting business class travel relocation et cetera.
And only investing in marketing events that will provide an appropriate rate of return.
These actions will help fund our continued investment in areas to support revenue growth. Additionally, the shift to higher value services, such as digital will continue to support higher margins.
From a people and talent perspective, our annualized attrition rate of 23% well, it's up from 19% in Q4.
Flat versus the prior year quarter.
We continue to focus on our workforce strategy and management.
Such as the announced retention program to recognize and retain our best talent.
We expect to incur an additional $48 million of compensation related costs. During the remainder of 2019 for this program.
Turning to our balance sheet, which remains very healthy.
We finished the quarter with $3 billion with cash and short term investments down $1.5 billion from December 31st 2018.
This decrease was largely due to the $1.8 billion of share repurchases completed year to date under our stock repurchase program.
Including over $1 billion of repurchases in the second quarter.
As a reminder, our short term investment balance includes restricted short term investments of $429 million related to the ongoing dispute with the Indian income tax Department.
We generated 479 million of free cash flow in the quarter.
Additionally, we had an uptick in dsos three days compared to Q2 2018.
Which negatively impacted free cash flow was $135 million.
Approximately half of the Dsos increased let's do the unbilled receivables related to the billing constructs of certain long term contracts.
We believe that we have the opportunity to improve our cash conversion and are initiating a working capital program that we expect will improve free cash flow by several hundred million dollars in the coming quarters.
Our outstanding debt balance was 746 million at the end of the quarter.
There was no outstanding balance on the revolver.
During the second quarter, we opportunistically repurchased approximately 18.7 million shares for approximately $1 billion and our diluted share count decreased to 564 million shares for the quarter.
On a year to date basis, we have repurchased over 28 million shares for approximately 1.8 billion.
We had 738 million remaining under our existing share repurchase authorization.
For cash generated from operations remaining cash on the balance sheet and our revolving credit facility. We continue to have access to frontier's liquidity gets on both capital return acquisition and acquisitions.
I'd now like to comment on our outlook for Q3, and the full year 2019.
For the full year 2019.
We expect revenue to grow in the range of 3.9% to 4.9% year over year or $16.75 billion to $16.9 billion in constant currency.
Based on current exchange rates this translates to growth within the range of 2.8% to 3.8%.
16.57 to 16.73 billion.
Reflecting our assumption of a negative 110 basis points for foreign exchange for the full year compared to an assumption that the negative 90 basis points in our prior guidance.
This guidance continues to reflect the muted outlook for banking and healthcare.
For the third quarter of 2019, we expect to deliver revenue growth in the range of 3.8% to 4.8% year over year or 4.23 to 4.27 billion in constant currency.
Based on current exchange rates this translates to growth in the range of 2.9% to 3.9% year over year or 4.2 to 4.24 billion.
Reflecting our assumption of a negative 90 basis points from foreign exchange for the third quarter.
For the full year 2019, we expect adjusted operating margins to be approximately 17%.
Based on the actions taken in Q2 and perspective cost alignment actions for the remainder of the year.
We anticipate adjusted operating margins of approximately 18% in both Q3 and Q4.
We expect to deliver adjusted diluted EPS in the range of $3.92 to $3.98 an increase from our previous guidance.
$3 97 to $3.95.
Primarily reflecting a lower share count assumption based on the stepped up repurchase was completed in the second quarter and the contribution incentive.
This guidance anticipates, a full year share count of approximately 562 million shares and a tax rate in the range of 24% to 26%.
Guidance provided for adjusted diluted EPS excludes realignment charges and other unusual items if any.
Net non operating foreign currency exchange gains and losses.
Clarification, if anybody Indian government entity application at the Supreme Court ruling related to the India defined contribution obligation and the tax effects of the agenda of adjustments.
Our guidance also does not account for the impact from shifts in the regulatory environment, including areas such as immigration intact.
With that we can open the call for questions operator.
Thank you we will now be conducting a question and answer session. If you would like to ask a question. Please press star one on your telephone keypad, a confirmation tone will indicate your line is in the question queue.
You May press Star two if you elect to remove your question from the queue for participants using speaker equipment. It may be necessary to pick up your handset before pressing the star keys in the interest of time, we ask that you limit yourself to one question.
Our first question comes from the line of Keith Bachman from Bank of Montreal. Please proceed with your question.
Hi, Thank you for taking the question and.
Welcome again, Brian or your first the first quarter under ownership so to speak and my question is going to be directed towards you is there's a lot of moving parts. It sounds like both on.
How I think about the offensive trying to chase revenues, while at the same time trying to balance cost.
And so we have your margin targets for the year, but just philosophically how should we be thinking about these two goals of trying to really nurture the revenue line while at the same time.
Trying to Austin to optimize the cost structure, how should investors be thinking about this over the course of this longer journey.
Hi, Keith well I mean, the first thing I'd say is I do not believe there are mutually exclusive but let me start first with revenue and then I'll spend some time on cost.
We grew as you know, 4.7% this quarter in constant currency.
Within that construct I would say we had very muted performance in two of our largest segments banking and financial services, and indeed health care, which represents 63% of the business.
It's one of the first things we have to do to get back to a stronger growth performance is to actually help turn those businesses around just the law of numbers becomes meaningful.
On top of that I think we're at the stage now of investing more in growth changing the dialogue in turn lead prioritizing growth.
As you've seen we have approved at this moment in time and I believe over time will add to this number.
Over 500 revenue generating resources or revenue support resources.
So the inclination is to get back to what we've always done which has been to focus on clients Centricity and revenue growth.
No cost is of course, a strategy is important to revenue growth first of all what are our strategic postures. How are we exposed to faster growing categories with the market, which are both technology categories, such as digital engineering or way of working.
He cloud as well as geographic categories, and that's why I'm pleased to see the continued momentum we have in the global growth markets, which is our non North America region.
Cost however, our important growth because you need to have a very efficient the disciplined cost base to be able to take pricing into deals to be able to absorb the renewals pricing pressure that we're seeing in our traditional business as well as being able to invest in the future I talked in my prepared remarks around the importance of pivoting to digital and the associated parameters of that smaller TCV contracts more contracts a different delivery model et cetera.
We also need to invest in people in M&A and indeed in the brand to make sure that we are more associated not just with the area of the business, where we have our loved by customers, but also with the pivot to digital many of these areas. As you know Keith are constrained assets, both M&A targets as well as even just getting digital resources into the company.
What I will say and I'm four months in at this stage, having interrogated the data for four months and having spent a great deal of time into transformation office.
Oh, I see I see huge opportunity here on revenue growth and indeed on cost I'm not going to get into a guidance discussion today around next fiscal year or indeed in multi year view.
But at this moment in time is this from my perspective is something that I only see opportunity has to be to improve our performance from today's performance.
Our next question comes line of T. Anson Huang from JP Morgan. Please proceed with your question.
Thank you so much glad to see a lot of heavy buybacks well done there just want to ask Nashville on gross margins. It looks like it's the lowest level we've seen.
Hi in some time, what what's driving this I heard the health care renegotiation I'm not sure if that was related there and any comments on pricing and contract mix issues execution.
That kind of thing and maybe any outlook on gross margin.
Thank you.
But since then it's Karen it's really to two factors one of which is the health care renegotiations as you talked about better.
40 basis point impact and that's all in gross margin.
And then also the fact that a head count continued to grow faster than revenue in the quarter.
Part of that is our digital operations business, which is growing considerably faster than headcount and then Oh, sorry company revenue at this point headcount grew in line with the revenue growth digital operations, but you know that does come at it typically has a lower gross margin than me a than the I.T. business.
But overall head count for the rest of the business to grow faster than revenue and the vast majority of that cost us sitting in gross margin and that is obviously one of the things that as we.
Continue to focus on tackling the cost of delivery for the organization, we will be looking to I have to optimize in the coming months and quarters.
Our next question comes line of Lisa Ellis from an often Moffat Nathanson. Please proceed with your question.
Hi, Good afternoon. Thank you, Brian as you're thinking about your overall strategic plan can you provide a little bit more color on how you're you believe you guys should be tackling the.
The deterioration in cognisance traditional services, meaning shifting away from more reaccelerating or whatever the right answer is you know those more traditional legacy piece of the business, which just at an industry level, maybe you know flat or even in in structural decline that strikes me as one of the tricare aspects things to navigate through here. Thank you yep.
It's a good question because you know we have strength in their existing customer base and if you look at the broader we have very strong positions in their highly concentrated in a set of customers, but we need to pivot more to digital and as we are pivoting to digital as they said there are different characteristics of the deals of the skill sets we need over to delivery models of the buying decision makers. If you will on behalf of the customers.
And this is an area, we definitely want to invest into the next S curve and make sure. We are from a capital allocation point of view, we de prioritizing that.
Now on to more traditional businesses some of them actually give us a foothold into the new.
Application modernization will go hand in glove as I said with the digital engineering space as we start thinking about cloud native applications, but in a broader sense of the word Lisa.
I'm, a big believer in drawing hard decisions across your portfolio and trying to understand where you need to be extremely disciplined from an investment and from a cost structure point of view in terms of optimizing legacy both investing in the new.
And those are disciplines, we need to obviously continue to drive hearing cognisant as we're investing in some of these newer growth categories that should accelerate or cagar growth.
You have seen in the last quarter, we have aggregated all of delivery under one leader previously delivery was fragmented through a number of leaders in the company.
And part of the task of that the Liberty leaders ultimately to drive a much more aggressive stance in terms of how we think about automation and tooling and put themselves in a position that we can be what I would term fit for growth.
In the legacy.
As well as the broader companies were optimizing the cost structure in particular for the legacy and freeing up capital to invest into new categories, which should be to growth driver for clubs and going forward.
Our next question comes line of Ed Caso from Wells Fargo. Please proceed with your question.
Oh. Thank you you're welcome can you talk a little bit about your capital deployment strategies from this space. Obviously, you deployed a lot of capital for repurchase where does M&A fit into the equation sort of order of magnitude and you know is there more share repurchase to be done in the near term. Thank you.
Well touched upon this in turn can jump in as well look we saw the opportunity to accelerate share repurchases in the last quarter as a as an opportunistic situation for us and we took advantage of that and I have no issues continuing to do so it can you just.
From an M&A point of view I have rejected some M&A and I have approved some M&A in the last four months. So we will look at that as a means to execute our strategy.
We're pleased to have acquired Zenit technologies, which closed most recently and obviously, we're using M&A as a means to an end. It is not a strategy its a means to execute a strategy.
Our priority right now is continuing to refine our strategic posture and making sure to the prior question, we get our capital allocation correct.
But we will look about M&A is something that we will use to execute your strategy going forward.
My my emphasis at this moment in time continues to be tuck in acquisitions that strategically align us to better competitive position in the market that we deem most relevant to us going forward.
Yeah, and I think it's a it's Karen obviously, the the guidance for the share count does not assume any more buybacks for the rest of the year as Brian said, we will continue to look at that Opportunistically.
But as you know we have far exceeded our initial expectations for this year in line with that framework, we outlined last year at Investor Day, where we said we expect to spend on average 25% of our global free cash flow towards buybacks, 25% towards dividends and 25% for acquisitions with the rest going to India. At this point there are no changes to that framework, if and when there are little obviously update accordingly.
Our next question comes line of Bryan Bergin from Cowen and company. Please proceed with your question.
Hi, Thank you.
Brian can you give us a sense on your just your view on the timeframe over which you think it's going to take for cognizant to address the company specific issues that you noted in your in the core verticals there.
And then a transformational year office Workstreams says, there's already been set up and that's in progress or is this now to come in Threeq and Fourq.
No. The transformation office was set up probably almost three months ago at this stage to be honest. It consists of six work streams as I said each is led by one of our executives committee members. Each one has a steering committee and then either working committee below that.
We've been very clear and outlining some positions that I want us to backfill too unexpected outcomes and as part of that.
Some short term wins, along the way. So we've been also very deliberate Brian in terms of the composition of the teams, making sure. We have people that are cross functional in nature people, who understand the markets. Both in North America and internationally people that understand delivery as well as the market facing commercial teams.
I really feel very very enthused from the I'd put it to work we've been working extremely hard.
On that but it gives me nothing but optimism that there is a huge opportunity for us to free up capital to invest in growth to simplify the organizational structure clarified roles and responsibilities and ultimately to make us much more successful in the market like accelerating revenue growth.
And having better solutions are being fair to our clients. So I feel great about that it is not a new initiative, it's been well underway and frankly I'm probably more advance in my thinking in the output of that than where I potentially considered I wouldn't be three months ago.
With regards to banking and healthcare, we changed out the leaders of both this will be some heavy lifting if I'm very honest some of it is because of cognizant specific issues that are reflective of the market. We already have some M&A in health care, where we are heavily exposed to for for firms that have merged.
And some good candidly relates to just the need for us to ship Foster to digital talk more thought leadership to be even more client centric entity to add more sales coverage and those are things that are underway at the moment, both in health care and indeed in our financial services practice or banking, Texas, I should clarify that our health care business in life Sciences is very strong it continues to grow double digits. It's one of the areas of our portfolio that I feel best about we have a strong strategy a strong leadership team. We know the end to end value chain for customers and therefore M&A is facilitated against that.
And we're doing a little better insurance than we are in the core banking business and as I said on the call. We make some structural changes in the banking team to really put dedicated teams behind hunting new logos behind some of our most strategic accounts that we deem platinum as well as more broadly I believe that in the world of digital extra.
Emphasis on thought leadership in an innovation agenda is required.
And then my dealings with clients over the last four months. It has become very apparent that we are very established in the legacy or traditional models put her brand attributes and props are thought leadership isn't where it needs to be on the side of the house that is digital and that is an area that we need to do better in.
If you do look at the competitive market in terms of what has been announced in the last quarter. It's also clear that there there is more growth out there in banking and indeed in health care and you know certainly from a banking point of view, we've seen most of our competitors in financial services and insurance grow from the low to the high single digits and need some even into the double digits. So we have to accelerate quicker get back on the attack make sure. We hone our thought leadership and get a team that are constantly in front of clients with a agenda around innovation that helps customers think about are they cutting et cetera, which are pivot to digital.
I have not seen any dialogue with customers.
Any macro concern around their desire to spend on innovation invariably the conversations were very clear if we show up with enough thought leadership and innovation they have budgets and of course, the pivot we need to make is to ensure we are cost disciplines on the legacy side of our business to ensure that we can absorb those costs demands up at the time of renewals was accelerating our investments into the new.
Our next question comes from Bryan Keane from Deutsche Bank. Please proceed with your question.
Mr. King your line is live.
Oh, Yes, hi, I wanted to ask about attrition I saw that it was up a little bit although year over year, it's pretty similar.
Where do you expect attrition to go do you expected to stay elevated or do you expect to come back down and maybe you can just talk about if you guys have lost any key managers or person now and just thinking about the morale of the company through all these changes thanks.
So let me start with the broader question around the leadership in corn in jumping on the attrition question isn't I mean to be very clear in the company of 300000 employees. We will always have leadership changes and it's pretty standard when you have a new CEO comes on board and we have been fortunate that at the time of.
My appointment then indeed before that the board secured a certain executives to see through a CEO transition and I'm grateful for.
Their ability to actually get us through that first four to six months of my tenure because it certainly allowed me to time to get deeper into the business and to make sure that I was ready to to going forward.
My perspective is we needed greater emphasis on our customers greater energy fresh perspective, and candidly in dealing with clients typically the questions. I was asking were how often you've seen her team to thought leadership, we brought to bear and how we stack up versus the competition and also who were some of the best people in the industry that they recognize and value as people when they are dealing with them. So we have made some very deliberate changes now of course, we've also had some other departures and I think thats normal, particularly in a company that has had a relatively stable leadership team over the best part of two decades.
This is not something I will say that I'm overly concerned about.
The emphasis on growth.
He is permeating through the organization to people who are touching customers day in day out is typically not the executive team with the client partners and those client partners are really in my mind enthused with the renewed focus on growth. After a few years of more focus on margin rate. If you will of course don't get this wrong I'm not taken just for granted by any means we are paranoid, but the first line of the PNM is the customer but from my perspective. This is a very manageable transition we're going through and we've made some strong internal promotions the new head of North America Dk has been with cognizant for over 20 years and is ultimately.
Focus and old has always been focused across multiple verticals on growth.
I'm also pleased to have promoted for deep in delivery somebody's Beamer cognizant for 23 years to enable us to get much more focus in terms of optimizing our delivery structures and we complimented them with some external hires some executives who used to work at Wipro. Indeed, more recently connection there who was the CEO of emphasis so my sense is we want to have the best team, we can get our hands on a team highly motivated energized moving with the same speed and urgency that I have and absolutely focused on their teams and under customers.
And Brian as it relates to the 23% as you said.
It is flat year over year and as you know there is some seasonality to attrition typically after bonuses are paid in March and you tend to see attrition pickup.
Really no changes in terms of the interest in terms of where it's coming from up and down the pyramid. The only exception being the director class attrition ticked up a little bit based on the actions that we took in June as part of the realignment program.
But that was the only real I would say significant change in attrition both in terms of geography, as well as up and down the pyramid.
I would expect is going to continue to be lumpy as we've said for some time now the job market is.
Strong and as well as as we look to optimize the cost structure for the organization that one it felt like we had to create in turn.
Our next question comes line of Jim Schneider from Goldman Sachs. Please proceed with your question.
Good afternoon. Thanks for taking my question as you look forward to the next few quarters sounds like you expect a continued muted trends in the financials and maybe some improvement in health care as you get to the end of the year I guess my question is.
And your Q4 guidance sort of implies that things remain muted a kind of across the board for some time is that just a level of conservatism relative to the outlook or are you actually seeing some.
Some headwinds in other segments that could be potentially offsetting that recovery.
Sure. So again this is Karen let me tackle that so Q3 to Q4, there is actually a decline in build rates of about two days and that will cost about $47 million on a constant currency basis.
So from a modeling perspective, if you were to take the middle of the range for Q3, and then the middle of the range for the full year.
Guidance that would actually say on a volume basis that Q4 will be flat.
With Q3.
There will be some puts and takes as we've talked about in our comments, we do expect to see some stabilization that health care off of the Q2 numbers not on a year over year basis. It will continue to show challenges, but we do expect it to stabilize on a sequential basis going forward.
We do expect as I said, a little bit of a slowdown in the technology practice, just given the tough year on year constant to get back into the back part of the year.
But that was in our guidance this quarter as well as last quarter. So no real change there from that perspective.
Our next question comes line of Joseph Foresi from Cantor Fitzgerald. Please proceed with your question.
Hi, I Wonder if you could talk about your positioning in digital do you think your.
Competitive in that business or is there a catch up to be done and I think most importantly, how does one company catch up.
In digital and close the gap if there is one thanks.
So this is Brian I'll start where position in digital and there are areas that ive been really blown away with and that really you know I've left reviews, feeling very proud about what we have and feeling as though we definitely have a strong foundation to build from.
I told today about the digital engineering team spent a lot of time with cognizant sufficient team, but more broadly within cognizant, we had legacy digital engineering as well as the application modernization efforts that collectively it really puts us in a position. If you think about 11000 plus resources with over 800 million of revenue it puts us in an incredible position too.
Increase our brand recognition and really dramatically change our position in the markets visa. These some of the.
Let's see currently known leaders out there I O T is a few hundred million dollars for us than we have broad offerings that are aligned by industry vertical and I'd expect us to go accelerate that as part of our strategy.
More broadly there are organic investments, we need to make there will be some inorganic plays we need to make there too.
But as I said I'm not working on something huge at this moment in time and it will be more tuck ins aligned to our strategy.
Of course behind and the organic and inorganic acquisitions, how do you scale digital when you need to have a brand you need to have capabilities and units of systems and tools into sales and marketing engines facilitators.
The play explicitly called out the fact that we are going to pivot, which requires us to do some work. It's more project oriented work, that's good and but you need to sell more projects they have lower TCV, but unlike the legacy business. We will have the same renewal price erosion that we are faced with in the legacy.
We need to have a set of Klein partners that are capable of speaking to the right level of the organization that typically will extend well beyond the CIO different decision makers and buyers right from the CMO up to the CFO and indeed, the CEO and then didn't know how to speak and how to follow up on what collateral to leave in what used cases to bring in and obviously you bought industry expertise to bring with them into the conversation more consultative selling and indeed, all these practical things that are very often overlooked but nonetheless critical in my opinion to running a world class operation things like sales Commission plans that needs to change and therefore, we need to Orient more commission towards aligning our sales into areas of the B that are aligned with our strategy. So that is not something weve. Historically done. It is something we will do going into the new year and indeed, the delivery capabilities from an agile delivery point of view becomes relevant as well.
I do feel that as we have near on and indeed offshore capabilities. If you think about something like digital engineering. If we are able to take the gildan part model that we have an extended notches from near shore, but indeed off to our offshore centers I believe we will have a huge advantage over some of the other players that you.
No. So listen this is an area that I'm pumped about I'm excited about the possibilities, we have and I've seen a lot of goodness in the operations. We of course now need to accelerate our investments in it and make sure that we take this strategy into execution rest assured we're very focused on that.
All right.
On your question.
Our final question comes the line of Rod bourgeois from Deepdive equity Research. Please proceed with your question.
All right. Thank you Hey, Brian So I appreciate your candor and admitting that cognizance weak growth in banking and healthcare is mostly due to company specific issues and my question is do you have a point of view at this point.
On what cognisance growth rate would be today, if it weren't for these company specific issues that you are needing to fix and I guess on a related note you're making a lot of internal changes now I'd like your perspective on whether you think these internal changes will cause additional growth disruption in the upcoming months.
So rod Hi, it's of course, it's hard to extrapolate the implication, but you can do a sliding scale analysis to understand that for every 100 basis points of improvements in health care or banking what is the implied implication on the broader cognisant story, but given they are 63% of the business.
You can clearly understand but these are meaningful shifts to our overall numbers in every 160 basis points.
160, or so million of growth is one point of growth for us and every $6 million of bottom line is one cents EPS for us. So these are important levers for us to get right.
We do have a lot of balls in the air at the moment and and Thats why we are very very deliberate around the transformation office, we have started with.
People, who know the company well they have been surrounded by management consultants, both internal and indeed external.
We have a huge operation cadence buying that any broad framework of change management communication and indeed, an execution layer that needs to happen.
And rod by definition.
You will always go home at night, and wondering if youre going too far too fast, but I've got to be honest I have a great sense of urgency I'm really proud to have this role and bridion proud to have inherited an organization that is in my mind full of talent and I want to leave and forward than I believe that we are going at the right pace to catch up where we need to catch up and to extend our leadership, where we think were in front, but.
We are spending a lot of time around operational excellence and rigor and making sure. We contextualize the exchanges, it's clear certain employees will be concerned around the amount of work in the hours and the pace and the decision, making but my belief is that my executive level have had a number of executive committee meetings that we have a cadence of two days every month Weve had some really really constructive meetings, where the team are on board and we are making decisions in my opinion needed at this moment in time to Percuvance and in a position, where we can unlock or our true potential.
Right and with that that concludes today's call. Thank you all for joining and for your question.
This concludes today's call you may disconnect your lines at this time. Thank you for your participation.