Cognizant Technology Solutions Corporation

Ladies and gentlemen, welcome to the Cognizant Technology Solutions first quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question at that time, please press star 1 on your telephone keypad and a confirmation tone to indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing star keys. In order to allow as many participants as possible to ask questions today, please limit yourself to one question. I will now turn the conference over to Katie Royce, Head of Investor Relations. Please go ahead, Ms. Royce.

Thank you, Rob, and good afternoon, everyone. By now you should have received a copy of the earnings release for the company's first quarter of 2019 results. If you have not, a copy is available on our website, Cognizant.com. The speakers we have on today's call are Brian Humphreys, Chief Executive Officer, and Karen 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 risk 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. Before I pass it to Brian, let me address one issue. We understand that there was some inadvertent communication of our release and other materials this afternoon shortly before market close. Obviously, we are going to take a look into what happened here. We simply wanted to let you know that we are aware of the issue and we will undertake a review. With that, I'd now like to turn the call over to Brian Humphrey. Please go ahead, Brian.

Well, thank you, Katie, and good afternoon, everybody. I'm pleased to join you today on my first earnings call as Cognizant's CEO. I've long admired Cognizant from my vantage point at other leading technology companies. Since moving into the role five weeks ago, I've been busy getting into the heart of the company's operations. I've traveled across three continents to listen directly to our clients and partners. I've conducted more than two dozen deep dives into our industries, lines of service, and regions. And I've met with nearly all of our global executive leadership team and talked to hundreds of our associates in person. I can tell you that the initial reasons for my enthusiasm about Cognizant have been strongly confirmed. I'll share some observations later in the call. This is a great company and I'm excited to have the opportunity to lead the company forward. we had a disappointing first quarter performance. We have a lot of work to do to get back to what I believe this company is capable of achieving to seize the market opportunity in front of us. In Q1, our revenue grew 6.8% year-over-year in constant currency to $4.1 billion. This fell short of our guidance and resulted in an earnings shortfall. Our softness in top-line growth resulted from a weak performance in banking and financial services, which was flat year-over-year in constant currency, and slowing growth in healthcare, excluding the contribution of bolder healthcare solutions. Our revenue performance reflects both external factors, including insourcing among a few large financial services clients and the spending pullback in healthcare clients that are in the midst of merger integration, as well as cognizant specific execution issues that we need to get behind us Offsetting this weakness in financial services and healthcare, we delivered strong double-digit growth in two of our other major business segments, products and resources, and communications, media, and technology. Later in today's call, I'll let Karen take you through the details of the quarter. Beforehand, I want to offer three observations. First, notwithstanding a disappointing Q1, The foundation and capabilities of business are solid, and the market opportunity is robust. I've spent enough time reviewing the business and meeting with clients and partners over the last five weeks to note it to be true. I want to stress that our customer centricity is as strong as ever. Having met face to face with hundreds of our associates over the past five weeks, I can attest to their passion for clients, incredible resourcefulness, innovation, and desire to win. Their winning spirit derives from decades of commercial success. This kind of spirit is hard to create, but once it becomes a core cultural attribute, as it is in Cognizant, it's also hard to break. Second, we know we can and must do better. We are committed to delivering consistent financial performance that aligns with the expectations that we set and communicate. And third, We also recognize that the first quarter revenue weakness follows a loss of top line momentum over the past 18 to 24 months. One of my top priorities is to act to restore top line momentum. Restoring our momentum goes to a question I've been asked many times by associates and others about revenue versus margin tradeoffs. I've long believed that it is possible to achieve solid revenue growth and drive margin expansion simultaneously. I've seen nothing today that changes this belief. To do both, we must be fit for growth. And by this, I mean establishing a healthy cost structure that allows us to be cost competitive, whilst enabling us to make investments that create value for our clients. Investments, of course, can take many forms, including marketing, demand generation, partnerships, reskilling, increased sales coverage, or increase spend in platforms, tools, and automation. I believe cost equals growth. They are not mutually exclusive. Therefore, as we said about reviving top line momentum, we will improve our cost structure as a means to invest in growth and unlock higher levels of performance. One example is our cost of delivery. During my recent trip to India, I saw firsthand how important our delivery teams are to our strategy. Through our customer engagements, our teams in India not only deliver, but also develop solutions and drive customer innovation that bring our digital capabilities to life for clients. This is a prized asset and a valued competitive advantage, but we must also be more efficient to ensure we can accelerate growth. As we said about getting fit for growth, change management, clarity of roles and responsibilities, and communication are critical. We will ensure that all of our associates understand the connection between top-line momentum and a healthy cost structure and that everyone is clear about our go-forward priorities and their role in making this happen. For example, I want our sales and delivery teams focused on customer acquisition upselling, and cross-selling within existing clients, co-creating innovative solutions to customer pain points, and maximizing customer satisfaction. Meanwhile, Karen and I will focus on ensuring a rigorous approach to non-investment costs while prioritizing investments related to growth. Once we get the balance right in steady state, I believe we can accelerate growth and deliver margin accretion simultaneously. That aside, in the meantime, I'm doing what you would expect a new CEO to do. I will dig into every part of the business to fully understand our strategy, market structures, competitive dynamics, client buying behavior, control points, and the engagement levels and collaboration of our teams. As I aim to leave no stone unturned, I've already launched a series of work streams to review our growth and margin opportunities. These work streams focus on areas including our organizational structure to assess role clarity and decision rights among our verticals, regions, and lines of service, and to ensure a clear accountability model that drives a culture that is both empowered and performance-oriented. Our sales model, including how we segment customers, align sales coverage, and establish sales performance metrics, and more leveraged sales commission plans. The Muslim battles in our digital strategy, as well as the practical matters of ensuring our pivot to digital will be successful via structural leadership and compensation actions. And our delivery model, particularly on lowering the cost of delivery through pyramid actions, tooling and automation, and optimizing the mix amongst our delivery locations. Finally, and acknowledging people are at the heart of everything, we have work streams focused on our leadership and culture, emphasizing rigorous data-driven talent management, succession planning, and leadership attraction and development. While we're on the topic of leadership, an essential part of my role is to ensure we have the right team in place to propel Cognizant forward. Having conducted over two dozen four- to five-hour business reviews in the last five weeks, I've had a good deal of interaction with most of our senior leaders. I believe we have a highly experienced, deeply knowledgeable, and accountable team that serves our clients and shares my commitment to getting the companies back to executing the basics well. Recognize, however, that when a new CEO joins, some reshaping of the leadership team is inevitable. and this has already begun to happen. As you know, with my arrival, Frank D'Souza moved into the role of executive vice chairman and will transition to vice chairman of our board at the end of June. Raj Mehta has stepped down as president. I'm not planning to backfill this role. I want to be deeply engaged in the business and also want to flatten our organizational structure so that we can take out layers of cost, communicate quicker, and move with greater speed and agility. With a view to sharpening our focus and accelerating our growth in digital business, I've just appointed Malcolm Frank as the new president of Codeless in Digital Business. Malcolm will bring significant customer centricity, passion, a strategic mind, and a partnership mentality to this critical position. And to improve our performance in banking and financial services, which represents 35% of Collison's annual revenue, I've asked Prasad Chintamanini, our EVP and President of Global Industries and Consulting, in addition to his existing responsibilities, to also assume the direct management of the banking business on an interim basis. Earlier in his career, Prasad led our Banking and Financial Services segment. Therefore, I am confident that he will immediately make a difference as we launch a search for a new head of our banking business. Prasad will continue to maintain all of his existing responsibilities in addition to his interim role. Finally, before turning the call to Karim, I would like to touch briefly on Cognizant's significant market opportunity. One of the things that drew me to Cognizant is our large addressable market. The rates of digitization across industries create a significant opportunity for us as clients as they recognize digital as both an opportunity and a threat. We built leadership positions in many industry verticals and strong client relationships where we can upsell and cross-sell our lines of service. We have an opportunity to further diversify our client base and on a geographic basis, There's a huge opportunity outside of North America with our global growth markets currently accounting for just over a quarter of our total revenues. I believe that we have the right strategy and portfolio of services and solutions to capture the market opportunity. And we will double down on execution to ensure success. We have been focusing our investments on six advanced capabilities that our clients need to become fully digital businesses. These six capabilities, which form the core of our digital strategy, are core modernization, digital engineering, where I'm really enthusiastic about capabilities enabled by Cognizant's soft vision, AI and analytics, intelligent process automation, industry and platform solutions, and interactive customer experiences. To this list, I have added one more capability. Internet of Things. The advent of 5G will vastly expand the impact of IoT and create significant opportunities across our verticals. As we help our customers be successful in a digital world, we need to extend our IoT portfolio of offerings and build out our IoT partnership ecosystem. We see ample headroom for growth in all of these areas, which offer strong margin profiles, and a combined market opportunity that we estimate to be in the hundreds of billions of dollars. As we get after these opportunities, we will be ultra-efficient in our legacy operations, prioritizing our investments, investing in partnerships, and ensuring we digitize our own operations. In short, my mission is to ensure that Cognizant is well positioned for long-term success. My aim is to leave no stone unturned so that we can identify all opportunities for improvements in growth, efficiency, and profitability. I look forward to giving you an update on our progress in the coming quarters. We have a solid strategy, engaged associates, and incredible client centricity. And we're fully committed to executing this strategy. Okay. With that, it's my pleasure to turn it over to Karen, who will give you an update on both our operational and financial performance, as well as the view on how we see the year ahead. Karen.

Thank you, Brian, and good afternoon, everyone. While the quarter started as expected, we saw a deterioration in our performance in the second half of the quarter, which led to a slower-than-expected Q1 revenue of $4.11 billion, an increase of 5.1% year-over-year, or 6.8% in constant currency. Digital, however, continues to be the most significant driver of our growth and now accounts for over a third of total revenue. Moving to the industry verticals, whereas Brian mentioned the Q1 underperformance was primarily driven by financial services and health care. Financial services growth was flat year-over-year in constant currency, driven by both banking and insurance. In insurance, growth was slower than our expectation at the beginning of the year, as executive transitions underway at several of our clients slowed the decision-making process in the latter part of the quarter, particularly around larger deals in the pipeline. In banking, we continued to see softness at a few of our largest banking clients, but during the quarter, we also saw a more conservative approach to spend with several of our regional banking clients in North America, including some banks that were impacted by M&A activity. Consistent with what we communicated to our investor today in November, two of our top five clients continue to show good growth while spend of the other three clients remains under pressure. We have, however, made progress in furthering our platforms and solution strategy for the banking clients through the recent acquisition of MeritSoft, a capital markets software platform for post-trade receivables and payables processing with offerings in regulatory, tax, operations, and fees and billings. and the previously announced partnership with three Finnish financial institutions to transform and operate a shared core banking platform based on the Temenos platform, which began as expected in the second quarter. However, we are seeing some cautiousness in the banking sector around levels of spend in the second half of the year with a moderating outlook for growth in their business. Moving on to healthcare, which grew 4.6% year-over-year in constant currency. Within our healthcare vertical, slower than expected growth of 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. The continued ramp down of an account in which we were a subcontractor to a third party also continued to negatively impact revenue. We expect these trends to continue and likely deteriorate in the second quarter, as some of these clients finalize new contract negotiations before embarking on the execution of their integration plans. Over the last several years, we've seen periods of heightened industry consolidation in healthcare, creating pressure on our organic growth rates during those periods. While the revenue associated with integration work that typically follows M&A can be meaningful, we recognize the volatility that has resulted from a handful of large clients over this period. As we broaden our client base within healthcare by expanding into new care clients through platform offerings developed for contracts such as P&G, as well as the provider space, the diversification of our client mix should, over time, contribute to more consistent growth. Life sciences saw broad-based acceleration in the quarter, contributing above company average growth. We are seeing good traction in large enterprise transformation deals and momentum within our industry-specific platforms such as the shared investigator portal for clinical trials. Products and resources had another strong quarter, showing 13.8% growth year-over-year in constant currency. We saw double-digit growth in constant currency across retail and consumer goods, travel and hospitality, as well as manufacturing, logistics, energy, and utilities. Building on the momentum that we saw in the fourth quarter, retail continued to perform well despite a handful of bankruptcies in some of our smaller relationships during the quarter. We continue to see strength in cloud and digital engineering services and increased demand for interactive IoT and analytic solutions across clients. Our communications, media, and technology segment had another strong quarter with year-over-year growth of 19.6% in constant currency driven by software and platform clients within the technology sector. Within media and communications, growth was primarily driven by digital services for media and entertainment clients to accelerate their transformation to modern media companies, partially offset by slower growth with communications clients involved in industry consolidation. Technology delivered double-digit growth driven primarily by our digital content solutions. Now moving on to geos. the rest of the world grew 7.1% year-over-year in constant currency. Results in Asia Pacific continue to be negatively impacted by the weakness in some of our larger banking clients. On a constant currency basis, the three industry segments outside of financial services saw double-digit growth in the quarter. Europe grew 14.3% year-over-year in constant currency. In continental Europe, we saw strength in life sciences and telecoms. While a few of our larger banking relationships in Europe remain under pressure, we did see good growth from several of our newer logos. While North America remains a significant and growing market for us, we see tremendous opportunity for growth in other parts of the world. We have made a number of organic and inorganic investments in continental Europe, which have given us a strong foundation for future growth. Going forward, we expect to increase our investments and drive an even greater focus on international growth, particularly in Europe. Switching now to margins. Our GAAP margin and EPS were 13.1% and 77 cents, respectfully. Our GAAP margin and EPS were negatively impacted by a $117 million accrual related to a recent ruling of the Supreme Court of India interpreting certain statutory defined contribution obligations of employees and employers which altered the historical understanding of such obligations by extending them to cover additional portions of an employee's income. Our accrual covers prior periods and assumes retroactive application of the Supreme Court ruling. However, as further discussed in the financial table for our earnings release, there is significant uncertainty as to how the liability should be calculated and whether the Indian government will apply the ruling on a retroactive basis. As such, the ultimate amount of the company's obligation may be materially different from the amount accrued. As a result of this ruling, the contributions of our employees and the company in future periods are required to be increased. This change will result in approximately $15 million of incremental expense for the remainder of 2019 related to the employer portion of this contribution. Adjusted operating margins which excludes realignment charges and the $117 million incremental accrual related to the India-defined contribution obligation, was 16%, and our adjusted ETF was $0.91 in Q1. Q1 margins followed our typical seasonality and were lower than the full-year projection. In Q1, we also had the continued absorption of headcount additions and wage increases and promotions from the fourth quarter. Our adjusted operating margin was below our expectations for the quarter due to costs related to headcount growth outpacing the lower-than-expected revenue growth in the quarter, which negatively impacted operating margins by 70 basis points and EPS by 4 cents, and an anticipated increase in bad debt expense related to a few bankruptcy filings by clients, primarily in our products and resources segment. This bad debt expense negatively impacted operating margins by 30 basis points and EPS by two cents. For the remainder of 2019, we expect margins to remain below our previous expectation, but to improve in the second half of the year as we align our cost structure with revised revenue expectations. As we discussed during our investor day back in November, while we have taken steps to improve our cost structure, there remains much more we can do to enhance margins through areas such as pyramid optimization, sustaining higher levels of utilization, and improved pricing levers. There is additional opportunity to simplify parts of our business unit overhead structure and take a hard look at the cost of delivery. Additionally, the shift to higher value services, such as digital, will continue to support margins. From a people and talent perspective, our annualized attrition rate at 19% is flat with Q4, but remains elevated. We continue to focus on our workforce strategy and overall management. Turning to the balance sheet, which remains very healthy, we finished the quarter with $3.7 billion of cash and short-term investments, down $843 million from December 31, 2018. This decrease is largely due to the $750 million of share repurchases under our stock repurchase program, including the funding of the $600 million accelerated share repurchase program launched in early March and annual bonus payouts. As a reminder, our short-term investment balance includes restricted short-term investments of $427 million. These restricted amounts are related to the ongoing dispute with the Indian Income Tax Department. We generated $163 million of free cash flow in the quarter. Following the typical seasonal pattern, free cash flow in Q1 is impacted by the timing of our bonus payouts. Additionally, we had an uptick of DSO of three days compared to Q1 2018, which negatively impacted free cash flow by $125 million and included an increase in unbilled receivables. We billed approximately 57% of the Q1 unbilled balance in April, which is in line with our historical norms. Our outstanding debt balance was $746 million at the end of the quarter, and there was no outstanding balance on the revolver. During the first quarter, we repurchased approximately 9.5 million shares and our diluted share count decreased to 575 million shares for the quarter. I would now like to comment on our outlook for Q2 and the full year 2019. For the full year 2019, we expect revenue to grow in the range of 3.6% to 5.1% year-over-year in constant currency. Based on current exchange rates, This translates to growth within the range of 2.7% to 4.2%, reflecting our assumption of a negative 90 basis points for foreign exchange for the full year. This revised guidance reflects a slower growth in the quarter one, as well as a more muted outlook for financial services, including banking and insurance, as well as health care. For the second quarter of 2019, we expect to deliver revenue growth in the range of 3.9%, to 4.9% in constant currency. Based on current exchange rates, this translates to growth in the range of 2.6% to 3.6%, reflecting our assumption of a negative 130 basis points for foreign exchange for the second quarter. For the full year 2019, we expect adjusted operating margins to be approximately 17%, and to deliver adjusted EPS in the range of $3.87 to $3.95. The reduction in our operating margin guidance is primarily the result of headcount which grew faster than revenue for the last two quarters. While we will better align our cost structure with our revised revenue growth expectations, we will also continue to invest in talent and development of solutions that further our position in the digital marketplace. In the second quarter, we expect adjusted operating margins to be in line with Q1 at approximately 16% while we take prospective cost alignment actions that will take several months to implement. This guidance anticipates a full year share count of approximately 572 million shares and a tax rate in the range of 24 to 26%. Guidance provided for adjusted ETF excludes realignment charges and any other unusual items, net non-operating foreign currency exchange gains and losses, the incremental accrual related to the India defined contribution obligation, and the tax effects of the above adjustments. Our guidance also does not account for the impact from shifts in the regulatory environment, including areas such as immigration and tax. As part of our balanced approach to capital allocation, we intend to utilize approximately 50% of global free cash flow annually for dividends and share repurchases. In Q1, we executed share repurchases that will reduce our average share count for the full year by more than our target of 1%. In addition, the Board has declared a Q2 cash dividend of 20 cents per share for shareholders of record at the close of this or on May 22nd. Additionally, we intend to utilize approximately 25% of global free cash flow on acquisitions and have closed two acquisitions thus far in 2019. We continue to look for acquisitions that enhance our longer-term strategy of enriching our digital capabilities, expanding our geographic footprint, and enhancing our vertical expertise. With that, I will turn the call back over to Brian.

Well, thank you, Karen. Before you take your questions, let me close by saying once again how delighted I am to have the opportunity to lead this great company. My 286,000 colleagues and I recognize that we have work to do to get Cognizant back to basics, and to strengthen our execution. We will roll our sleeves up and ensure that we tenaciously follow through on our strategy to produce the kind of results I know Cogglison is capable of achieving. We are all dedicated to our clients. We are all committed to advancing Cogglison's pivot to digital and spurring the next phase of growth and success. With that, I'll ask the operator to open the line for your questions.

Thank you. We'll now be conducting a question and answer session. If you'd like to ask a question, please press star 1 on your telephone keypad, and a confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like 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. One moment, please, while we poll for questions. Thank you. The first question is from the line of Lisa Ellis with Moffett Nathanson. Please receive your questions.

Hi. Good afternoon, guys, and welcome, Brian. I look forward to working with you. Thank you. Can you give a sense, I know you've just been on the ground, like you said, for five weeks or so, but given you've landed in an organization that's clearly in this, you know, pretty tough period of transition, can you just map out for us a little bit how you envision the next, six to 12 months for you looking like? Like, where are you going to focus? Are there some immediate shifts and changes you can already envision you might want to make, things you want to be doing faster, investing in more aggressively? Any just early thoughts? Thank you.

Yeah, I'm happy to do so. And ultimately, over the last five weeks, I've spent my time across three continents and ultimately have been prioritizing business reviews, spending time with our associates, and spending time with clients and partners. And to a great extent, that will be how I will continue to spend my time going forward. From my point of view, the great news is that we have an exciting market opportunity. The potential is there. But one of the things we're going to have to get back to doing is understanding the relevant tradeoffs between costs, investments, and growth. I don't view costs and investments to be the same thing. But I do view cost and growth to be the same thing. We have to be fit for growth. So in order to do so, we need to invest in growth. In order to invest in growth, we need to free up dollars for investment. And to a certain extent, Lisa, I really feel as though we have to restart the engine that was the secret sauce of Cognizant. We have very engaged associates who have a winning spirit. There's a great opportunity out there, but we have to go back to making the investments, getting our cost structure right. really embracing digital, and doing the basics well. And sometimes those basics in companies can be overlooked in terms of structural decision rights, sales commission plans, et cetera, et cetera. If we get all of this right, I think we'll be in a position to execute our strategy and to do well.

Thank you. Our next question comes from the line of Tin Sin Wong with J.P. Morgan. Let's just hear their question.

Thank you, and Brian, thanks for the thoughtful comments. I wanted to ask you, you know, our understanding was that the board, when they selected the CEO, that would ultimately carry out the strategy that they laid out at Investor Day late last year. So given what you've learned and what you described in 1K results, are the company's longer-term growth and margin goals still relevant, or are changes required, again, based on what you've seen and observed? Sure.

I can't really comment on what the board saw in a candidate, so the question is for them to answer over time. What I will say is that slightly since my tenure, I'm still very much on the steep learning curve, as you can well imagine. I'm delighted to be here and obviously optimistic about our potential and why. Of course, as I said, the market opportunity is there to be taken. I'm surrounded by a lot of really smart people with broad industry knowledge, and I'll be leaning on them to help me execute our plan in the years ahead. We do have a base of associates, as I said, that are client-centric, which is a huge asset to have a winning spirit, and that's based on years of commercial success. Now, we have a set of customers who like Cognizance, and that gives us an opportunity to upsell and cross-sell to our installed base, but we also have an opportunity to go after new customers within our largest and most successful verticals, as well as in the other segments, and indeed as power and vegetable and within growth markets. And we have to embrace digital further and leverage our strong C-suite relationships, notably at the CIO stack, to better penetrate the rest of companies in their digital ambitions. What's easy to articulate in one hand is obviously harder to execute. You asked me what needs to change, but certainly from these comments, and I'll be in a better position to address that, obviously down the line in the outer quarters. Maybe let me answer your question indirectly by saying I'm touching upon some of the work streams that I started. What's really clear and important to me in good companies is that roles and responsibilities are clearly defined. Teams are empowered. With responsibility, clarification, and empowerment, so too goes accountability. And core to all of that is decision rights. And we have a matrix, as every company has a matrix, but we need to, and I will explore the D, if you will, in a rapid between horizontals, verticals, and indeed the markets. There must be clarity in the matrix. I also really want to look at how we get after the sales opportunity, and not just in terms of the CIO versus the rest of the C-suite, where we, in theory, should be able to better leverage our CIO relationships to cross-sell into the CMO, the COO, and indeed the CEO. and shift ultimately from the run portion of the business, which will always be under some degree of constraint, into the optimization or transformation portion of the business, leveraging more of a shift to advisory and indeed our digital offerings. We have to look at some of the basics as well, customer segmentation, commission plans, accounts-based marketing. All of these are critical to growth, and it's important to get the basics right, and of course, as I just spun our delivery model. So, look, in short, I'm learning the business, but every passing week I get a little smarter, but I've done a lot to learn, and I'm rolling my sleeves up, as you can imagine, with the team. Spending time with clients, and they themselves will have a huge role to play in informing my priorities going forward.

Thank you. The next question is from the line of Brian Essex with Morgan Stanley. Please proceed with your question.

Hi, good afternoon, and thank you for taking the question. I guess either Brian or Karen, I was wondering if we might be able to get a little bit more color on the banking and financial services side. And it sounds like things were a little bit softer than you anticipated, particularly with North American regional banking clients. I was wondering maybe if you could help us wrap our arms around that a little bit to understand, you know, where the softness came from and is this a temporary thing issue or, you know, might there be a fatter pipeline kind of in the back half of the year as you kind of progress through the year?

Sure. Brian's turn. I'll take that. So I think, you know, certainly as we've talked about for several quarters, the top five banking clients have been under pressure and we saw some nice recovery in two of the top five last year and that continues into this year. So we haven't really seen any change in the profile of those clients or their behavior but But we did, as we said on the call in my comments, see some pullback in the regional banking clients. Some of it was M&A, as we've always talked about when there are acquisitions happening between clients, particularly when both sides of the acquisition are clients of ours. We do tend to see some pullback as the deals are getting finalized and closed before integration spending. So there was a little bit of that in the quarter. But we saw some general softness in some of our other regional clients as well, not on a material basis in any individual client, but a number of small pullbacks across the industry. I think it's early to say what's happening in the broader market, but, you know, at this point, I don't expect to see significant recovery as we move into the back half of the year. but neither do we expect to see significant deterioration beyond what we've already seen with the three of the big-size banking clients. But it was a little bit of a surprise in the quarter as we got further into it.

The next question comes from the line of Keith Bachman with BMO Capital Markets. Please proceed with your question.

Hi. Thank you very much. Brian, this is for you, and I wanted to start with, You're lowering estimates, which I don't candidly think is a surprise, but the magnitude's certainly a bit larger than we were thinking. And as you indicated, you've been there a short period of time. And so I just wanted to get kind of comfort level that you had enough time to at least give some assessments that would suggest that the, you know, the estimates are set at a reasonable spot. And the second part of the question is, you are taking a fresh look at things. And one of the things that does surprise me a little bit is the free cash flow targets. In other words, using 25% of your free cash flow for acquisitions. And given your attach rates to some of the troubled banks and the gravity that that poses, I would think that Cognizant would be well served by perhaps leaning a bit more on M&A as your friends from Accenture are doing at other firms. The corollary part of the question, if you saw opportunities that would advance the cause of cognizant, would you be willing to flex away from some previous statements that were made to advance cognizant? That's it for me. Thank you.

Well, thank you, Keith. Let me first start with capital allocation because the M&A question is inherent in that. But you can well imagine, Keith, our board of directors and I will continue to evaluate our framework on an ongoing basis to ensure we're maximizing value for people like you and our shareholders generally. We do have a very strong balance sheet. At this moment in time, there is no change in our previously disclosed capital allocation framework. I will say more explicitly to the question on M&A, It has been and will continue to be a lever to execute our strategy. I'm very clear in my mind that M&A is not a strategy. It is a means to execute a strategy. So all acquisitions that come forth to me need to be contextualized against our strategy, and we need to have clear business ownership and sponsorship and a clean line of sight to integration. At the moment, we're not working on major acquisitions, and I'm more historically favorable to token acquisitions as opposed to anything beyond that. And I do think we should be able to use those as a means to an end to drive further revenue growth in line with our strategic ambition. Back to the first part of your question, which relates to the margins. Look, everybody knows I've been here five weeks, so I arrived on April 1st, the quarter was closed, and immediately we started looking at the results and trying to decompose and bound. understanding what happened in the latter part of the quarter. By definition, I've been focused on what is a secular trend versus a cyclical trend, what is an external factor versus a cognizant specific factor. I'm pleased with the work that Karen and I have done to try to get below those as best we can. I'm obviously focused on putting guidance out there that I know we can actually execute against, and that will enable me to invest in the long-term health of the business to ensure we can drive So at this moment in time, that's as much as I can say.

And I think, Keith, if I could just add to Brian's comments on capital allocation and acquisitions. As you'll recall, at Investor Day, what we outlined was a framework that on average in a given year, we would deploy 50% of our free cash flow for buybacks and dividends, 25% for M&A, and then 25% on average goes to India. We continue to have a very strong balance sheet, both with cash and excess capacity for debt if we need it at the appropriate time for acquisitions or other investments.

The next question comes from the line of Brian Keene with Deutsche Bank. Please proceed with your question.

Hi, good afternoon. I know you guys keep guidance on February 6th, so I'm just trying to understand in the first quarter the miss of op income was by, you know, $100 million per streak. And margins ended up being down 170 basis points. So, and I know we talked about margin expansion this year. Margins were going to be up 100 basis points. Now they're going to be down 100 basis points. So I'm just trying to foot, you know, what happened to the margin expansion. And just the shortfall in revenue for the quarter doesn't make up for it. And I'm sure you knew about headcount and raises already. So I'm just trying to reconcile the differences. Thanks.

Yeah, so I think, Brian, the way to think about it is that But the revenue shortfall was clearly the biggest piece in the sense that we had ramped up hiring in Q4 and in the beginning of Q1 for the anticipated growth this year. And as you know, it's hard to – you can slow down the hiring, but once you have the people on board, you need the revenue to support that. And, you know, when we – while we did not give quarterly margin guidance, you know, certainly our Q1 margin does tend to be below the full year average. And so while the 16% adjusted operating margin was slightly below our own expectations, you know, we had expected that there would be a ramp of margins as we went through the year, as revenue continued to build, and as we were able to deploy the headcount that we had bought on in Q4 in the early part of 2019. And, you know, I think that you'll see, as we've said in my comments, that margins will be a little bit of a different seasonality this year. So margins, adjusted operating margins in Q1 and Q2 will be roughly the same. Q2 tends to be our strongest margin quarter, but given the pullback of revenue and the headcount that we have on board now, Q2 margins will be similarly in line with Q1, but then we'll see the ramp as we get back into Q3 and Q4, and we can better align the cost structure to the revenue.

Thank you. Our next question comes from the line of Jim Schneider with Goldman Sachs.

Please receive your question. Good afternoon. Thanks for taking my question and welcome, Brian. Maybe if we could go back to the conversations you've had with clients over your initial month at the company, can you maybe just talk philosophically about what they've told you about their willingness to potentially give you more business if business conditions were different? In other words, For example, with respect to pricing, do you believe that you could actually accelerate revenue growth at the company by potentially being a little bit more aggressive on pricing? And maybe understanding that you don't believe there's a direct tradeoff between revenue growth and margins, just talk about your thoughts on how you could reaccelerate revenue growth beyond all of the kind of temporal issues that are going on with the clients in banking healthcare right now.

Yeah. Look, I think it's a good question and inherent in that is the notion of elasticity and also our position within clients in terms of where we stand, not just in the legacy but also in the new. I've seen quite a lot of clients across three continents and I've approached those meetings very openly soliciting feedback on cognizance, on our brand, on what we stand for, on our client teams and delivery and project management and trying to obviously in the same vein understand what those customers are working on And I would say very clearly and consistently, spend pressure continues on the run side of the business in financial services everywhere else, candidly, it's been a consistent theme. And all firms are fully aware of the do or die notion that digital disruption brings their way. So they are in a highly competitive market with legacy competitors as well as new. And so very often the message is we have to find ways to get our investment down in legacy, free up dollars for investment in security, but also free up dollars for innovation to enable them to better participate in the digital world, if you will. So there is spend, but it's not always what we traditionally played. And so our task is to optimize our portfolio, being as efficient as possible in our legacy business, and better positioning ourselves then in the digital world. That brings with it complications as well as opportunities. The nature of the contracts, from longer-term contracts to more project-based contracts. This is a factor we have to juggle with, the nature of the skills required to get at those opportunities and the relationships, how we get in the front door, how we leverage our strength with CIOs and strong customer NPS to sponsors with their CMOs, COOs, CEOs, how we get the right skill sets, who we talk to, how we talk to them, how we follow up, what collateral to leave, you name it. It's fundamentally important. an opportunity for us, but also something we have to grow into and continue to flex your muscles in as we become more of an advisory element. Cognizant digital business is really important to making that happen. Winning new logos, of course, will enable us to grow too. But more broadly, almost two-thirds of our business is in financial services and healthcare. So it's important that we turn those businesses around. It's important that we butcher some North American business with further growth in global growth markets. which grew 12% in the first quarter. And if we get all of those things right and invest for growth, I am confident that over time in a steady state, we will be able to simultaneously deliver better margins and accelerated growth. At this moment in time, of course, we have a lot of work to do.

Thank you. The next question comes from the line of Rod Bourgeois with Deep Dive Equity. Please proceed with your question.

Hey, welcome, Brian, and nice to have the fresh perspective. Hey, I just want to go back to where we have been recently. I mean, it does seem that the analyst day and the related financial targets that were set by the outgoing management, it does seem that those targets were awkwardly timed. And so I just wanted to inquire a couple things. One, has the process for forecasting, you know, risk grading, prospects in the pipeline, and so on. Has that process changed, you know, as you've come to the helm? And two, is there a plan for the role that Frank will be playing going forward? Is he ultimately going to transition out, or is he staying for an extended period? So any clarity on that in the context of, you know, having these financial targets that we're were issued when there was a CEO change imminently about to occur, and I think a lot of people are now, especially now, wrestling with the awkwardness that was created with that. So has the guidance process and the forecasting assumptions and approach changed, and is there a plan for the role of Frank going forward?

Well, let me first start with the latter question around Frank, who's been nothing short of a gentleman in the transition period with me, and I've been delighted to have the opportunity to spend time with him and work with him He's somebody I reach out to almost on a daily basis to get guidance and counsel, but in the same vein, it's clear that he has moved on from the CEO role for the next three months or the next two months at this stage to move into an EVP or executive vice chairman role, and thereafter will transition to the board, and I'm sure will be available for me in a non-operational capacity, but as a counselor as needed and as I choose to use. With regards to the process for forecasting and the investor day guidance and Q1 guidance, I can't really comment on the past. It's very clear obviously that I understand the importance of setting expectations we can meet and consistency of earnings is something that I hold near and dear to my heart. We will continue to work to get rigor in our forecasting process and not just forecasting but an annual budget process. Forecasts happen on a monthly basis. bottoms up from accounts. But at the end of the day, we set a cost structure and we set leadership bonuses based on the annual budget. So we want to make sure we're rigorous, not just against forecasting and predictability of guidance, but also against the adherence plan as we enter a year.

Thank you. The next question comes from the line of Darren Peller with Wolf Research. Please proceed with your question.

Hey, thanks, guys. Listen, just to dissect the shortfall on revenue versus your initial outlook, I mean, when we think of the magnitude of, you know, $500 million, $600 million of revenue here, I guess I'd just love to get a little more granularity as to, you know, how much of this is a handful of large clients, how much of it is broad-based. And then, really, I didn't hear you say a digital revenue growth rate. Maybe if you can give us that and if that's not been really enough to offset what you're seeing. Is legacy revenue decelerating at a faster pace now? Thanks, guys.

So, Darren, it's your turn. So the digital, what we said in my comments was that it's about a third of revenue now. It grew above 20%, so low 20s, so consistent with where it was running towards the end of last year. So no real significant changes there.

Thank you. Our final question is from the line of Brian Bergen with Cowan. Please receive your questions.

Hi, thank you. I wanted to ask on health care. With the political cycle starting to ramp and then, you know, the rhetoric around health insurance also ramping, can you discuss what you're seeing in spending behavior in conversations with your managed care clients? I'm trying to understand the underlying outlook here that's independent of the captive and also independent of the account ramping down. And really, when do you expect that segment can potentially show a turn of a corner here?

So it's Karen. So I don't, I think the behavior we saw in Q1 was really related primarily to the merger and acquisition activities that we've seen in healthcare. So as we all know, there have been two very large mergers in the last few months. All four of those companies were clients of ours. And that was the majority of where we saw some pullback and where we expect to see some deterioration, as we said, going into Q2 and sluggishness for the rest of the year. And then we had one large client that did accelerate the move to a captive during the quarter. At this point, I think it's more about those client-specific situations versus anything that might be happening in the broader regulatory environment with healthcare. But I'll ask Brian to maybe add some color to that as well.

Well, thanks, Karen. Well, first of all, I'd like to indicate, obviously, life science has been very strong and grew double digits, as we said. And the healthcare payer business, we've had a different story and certainly excluding Some M&A has been slow. I would say on a positive nature, healthcare is still about 18% of the nation's GDP, and we're starting from a position of strength. So we need to understand, of course, we've had disappointing healthcare results this quarter, but we need to do better. In the last few days, I've spent about three hours with CIOs of some of the largest healthcare companies in the world. and the message I received was very clear. Helped them on the run to optimize their opportunities or to optimize their run business and get cost savings and yet they are very open to embracing cognizance on their transformation and digital agenda where we have so much opportunity and so it's for us now and Malcolm in his new role to get after those opportunities and make sure we bring our assets to bear in customers where we've historically had very strong customer satisfaction and growing business in prior years.

Okay. And with that, that concludes today's call. Thank you all for joining and for your questions.

Thank you. Thank you for joining today's teleconference. You may now disconnect your lines at this time. Thank you for your participation.