Cognizant Technology Solutions Corporation

Ladies and gentlemen, welcome to the Cognizant Technology Solutions third quarter 2019 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'd like to ask a question at that time, 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 who are using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Thank you, and I would now like to turn the conference over to Katie Royce, Global Head of Investor Relations. Please go ahead, Katie.

Thank you, Rob, and good afternoon, everyone. By now, you should have received a copy of the earnings release for the company's third quarter 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 calls 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 methods that we believe provide useful information for our investors. Reconciliations of non-GAAP financial measures, where appropriate, to the corresponding GAAP measures can be found in the company's earnings release and other filings with the SEC. With that, I'd now like to turn the call over to Brian Humphreys. Please go ahead, Brian.

Well, thank you, Katie, and good afternoon, everybody, and thanks for joining us in today's call. Over the past few months, we've initiated what we expect will be a multi-year evolution of our business aimed at returning our company to historical levels of performance. We view this as a systematic process of revitalizing the company and one we're pursuing with rigor and urgency. Today, I want to clarify where we are in this project and where we're headed by briefly covering our Q3 performance and then reviewing how we've begun to operationalize the conclusions of the transformation office, including our refined strategic posture, which aligns to our clients' digital imperatives, and our plan for resetting our cost base to facilitate investments in growth. Let's begin with our third quarter earnings. Q3 revenue grew 5.1% year-over-year in constant currency to $4.25 billion, and non-GAAP EPS was $1.08. In an uncertain economic climate, our year-over-year performance in North America improved modestly in the third quarter. As we've discussed in prior calls, our ability to accelerate the company's top-line growth depends on revitalizing our North American performance. and in particular our banking and financial services and healthcare businesses, both of which are under new leadership. While we have more work to do, we now have highly engaged strategic leaders running these businesses who bring a fresh perspective and huge client centricity. Arguably, even more important than the modest year-over-year growth improvement we've seen is the new energy we have in our North America leadership team, and our clients are noticing this. At a global level in Q3, banking and financial services was up 3% year-over-year in cost and currency, and healthcare was down 90 basis points year-over-year in cost and currency. In banking and financial services, against the backdrop of growing demand for DevOps and some insourcing of skills, we see cost pressure in the traditional business with growth opportunities in digital, with particular interest in cloud, digital engineering, AI and analytics, and interactive. Similar dynamics exist in healthcare, but here revenue growth also continues to be impacted by rate reductions and volume discounts from clients in the midst of merger integration. Our momentum continued in our other two business segments, products and resources, and communications media and technology. Both posted double-digit revenue growth in constant currency year over year. Later in our call, Karen will take you through the details of the quarter, including the business segment and markets commentary. Let's turn to my second topic, operationalizing the conclusions of the Transformation Office. As a reminder, upon joining Cognizant in April, we established the Transformation Office to identify, prioritize, and put into action key initiatives aimed at accelerating our revenue growth and unlocking the full potential of Cognizant. Following six months of engagement by 250 of our leaders, we have now identified, amongst other things, our strategic focus, operating and commercial models, global delivery structure, and our cost base and processes and tools required to enable us to be fit for growth. As a result, we are now in execution mode, putting into action key initiatives aimed at facilitating investments and growth, going to market with a sharper strategic focus, working more closely with our clients, continuing to evolve our skill sets, and creating a leaner and simpler operating model. Let's start with our strategy. I continue to allocate significant time to face-to-face meetings with the C-suite of our clients. I find these meetings essential because they allow me to gain insights into the key trends by industry, customer pain points, and desired business outcomes. Clients across all industries are confronted with the risk of being disrupted by next generation, nimble, digital native competitors. But they are redirecting their focus and investment to digital and embracing DevOps and technologies like cloud, digital engineering, analytics, AI, and automation. We spent the past few months sharpening our strategic posture to align directly with clients' needs to become modern, data-enabled, customer-centric, and differentiated businesses. Our strategy has two parts. First, protecting and optimizing our core portfolio, which includes efficiency, tooling and automation, delivery optimization, protection of renewals, strengthening our industry alignment, and scaling our international footprint. And second, winning in four key digital battlegrounds, data, digital engineering, cloud, and IoT. These four areas enable clients to put their data at the core of their operations, improving the experience they offer their customers, tapping into new revenue streams, defending against destructors, and reducing costs. The two parts of our strategy reinforce each other. It's our core portfolio that has built our strength in the market. For instance, our deep relationship with clients who lead their industries, our reputation for responsive and reliable delivery, and our historical strength at the application layer mean that we know how to help clients transition from managing their current legacy state to enabling their digital future. We are investing aggressively and are determined to win in these four digital battlegrounds. And as we do so, we expect to accelerate our revenue growth. I want to offer a bit more context about these four areas, starting with data, which is at the heart of our strategy because it's at the core of our clients' competitiveness. No matter their industry, clients must quickly get better at storing, managing, reporting, analyzing, and reusing their data. Clients need to leverage enormous amounts of data to fuel AI-based platforms that can transform customer experiences, drive automation, and provide management insight. This is causing a shift from legacy to next generation data services like data modernization, AI, and machine learning. We're helping our clients make the leap from systems of record to systems of insight and engagement. It starts with data engineering, including basic things like customer and product hierarchies. Turning to digital engineering, to compete effectively, clients need to become software-driven enterprises. And to do so, they are replacing traditional application development with digital engineering to build leading-edge, consumer-grade experiences. and infuse software into their products, services, and customer experiences. Cloud, a third digital battleground, is just as critical to clients' digital journeys, given that an estimated 50% of all workloads sit on public and private clouds today, a figure set to rise to 80% in a couple of years. Our clients need help migrating their workloads as well as the entire spectrum of cloud management, including monitoring, notification, provisioning, and orchestration, governance, and security. We aim to significantly enhance our partnership with leading scale companies, hyperscale companies, and SaaS vendors. Our fourth battleground is IoT. An exciting space given that 75% of businesses are expected to increase their IoT spending in the next five years. And 40 billion plus devices are expected to be IoT connected by 2025. The adoption of IoT, enabled by five generation technology, is sparking an explosion in distributed and edge computing. A vast array of sensors and industrial IoT devices and solutions will proliferate across businesses, cities, and environments of all kinds, significantly changing use cases and accelerating adoption. For clients, IoT offers the ability to instrument everything for constant insight. If you look back at our recent acquisitions, such as SoftVision, which expanded our digital engineering capabilities, and Zenit Technologies, which expanded our IoT portfolio and our life sciences domain expertise, we've been methodically deepening our expertise in areas that we believe will provide the greatest value to clients while generating the best return for Cognizant. Our latest step along that path is our agreement to acquire Coutinho, a leading consultancy that specializes in helping global 2,000 clients speed their digital transformations by leveraging enterprise DevOps methodologies and advanced data platforms. Cognizant's approach to cloud migration, core modernization, and cloud security is reshaping how enterprises build their infrastructures. And these cloud capabilities will enable us to offer transformative cloud-based solutions to our clients. We expect this transaction to close later this quarter. The refinement of our strategic posture also highlights a subset of our portfolio that is not in line with our strategic vision for the company, and therefore an area to exit. Within digital operations, we have a content operations business that offers a wide range of business process services to clients across all industries. Some of these projects involve ensuring proper brand and business experiences, such as integrating our healthcare patients or determining whether online maps are accurate. But within one subset of the content operations business, our work is largely focused on determining whether certain content violates client standards and can involve objectionable materials. We've determined that this subset of work is not in line with our strategic vision for the company. While we intend to exit this work, we recognize that cleansing the web of objectionable content is a worthy cause and one of which companies have a role to play. For this reason, We have decided to allocate $5 million to fund research aimed at increasing the level of sophistication of algorithms and automation, thereby reducing users' exposure to objectionable content. Over the coming quarters, we intend to comply with our contractual obligations and determine the best path forward with effective clients. Exiting this subset will impact our financial performance in the coming year and also affect approximately 6,000 roles. In the months ahead, We expect to work with our partners to explore ways to transition roles to alternative vendors, thereby reducing the impact to our valued associates. As a reminder, other Cognizant Digital Operations content work will continue. In recent quarters, I've discussed the importance of simplifying our organizational model to enhance role clarity, empowerment, and accountability. whilst ensuring we further increase our client centricity and optimize our cost structure. Over the last few months, the Transformation Office and Indeed Client Feedback has identified a series of measures to help us progress against these goals. And today I want to give you an update on some of the decisions we have taken. These actions include returning to our simpler two-in-a-box model of client partner and delivery partner for a more seamless client experience and greater agility in front of the customer. I previously announced consolidation of the delivery organization under one delivery leader reporting to me. Significantly increasing investments in automation and tooling to enable more streamlined and efficient processes, higher productivity, and lower delivery costs. Combining Cognizant digital engineering capabilities with Cognizant soft vision thereby creating a powerful team focused on software product development and application modernization. Extending our global brand, developing greater thought leadership by industry vertical and better positioning Cognizant in the market as a leader in digital by uniting all marketing under a recently hired CMO reporting to me. Strengthening Cognizant consulting capabilities in select geographies and verticals, while complementing our targeted capabilities with greater partnerships. with a leader again reporting to me. Aligning our specialist sales capabilities to the service lines, albeit with an industry intersection point, to ensure the highest competencies and capabilities are available to our client partners. And lastly, in our commercial teams, the implementation of more leveraged sales compensation programs and the development and deployment of a RAD model, or retention acquisition development, to optimally segment our clients and future clients thereby allowing us to better hunt and farm. These changes, for the most part, will become effective January 1, 2020. Against this strategic backdrop and a set of organizational decisions aimed at ensuring strategy execution, today we are also announcing a cost reduction program. In any people-intensive business, cost reduction always involves difficult choices. With an eye to evolving our skill sets and freeing up capacity to invest in growth, we've made the decision to remove approximately 10 to 12,000 mid to senior level associates from their current roles in the coming quarters. This gross reduction is expected to lead to a net reduction of approximately 5 to 7,000 roles as we aim to reskill approximately 5,000 associates, thereby lessening the impact on our associates and allowing us to reduce lateral hiring. These numbers exclude the approximately 6,000 roles impacted by our decision to exit a subset of our content operations business. But as previously stated, we expect to work with our partners to explore ways to transition these roles to alternative vendors, thereby reducing the impact on our associates and also reducing any associated charge. Establishing a healthier cost structure is but a means to an end, and that's to drive revenue growth. We free up costs, we've identified a series of investments that require funding, including the previously-announced hiring of approximately 500 revenue-generating associates over the coming year, a combination of customer-facing and sales support professionals who will help us expand existing accounts and generate new ones, significant investments in Cognizant Academy, our internal learning center, and in technical skills as we aim to reskill and redeploy our talent towards digital imperatives. accelerated investments in tooling and automation, and increased investments in marketing and branding as we aim to strengthen our international operations and indeed our digital brand. Karen will provide more detail on our 2020 Fit for Growth plan, including the expected completion date and run rate savings, along with the charges we expect to incur. We will take great care to treat our associates with the dignity and respect they deserve, and to minimize any internal distractions caused by our actions as we get the company back to achieving its full potential. I've been in CEO role now for a full seven months, which has given me the opportunity to considerably deepen my knowledge of our operations, our market opportunity, and our clients. And three things are resoundingly clear to me. First, we built an enviable position in a large and attractive market that's expected to contain continue growing at a steady rate. Most of our clients we serve are still in the early stages of their transformation. They need our expertise in a distinct set of digital technologies, coupled with our intimate knowledge of their technology environments to fully digitize their businesses. Second, the significant time I've been able to spend with our top accounts convinces me that our clients love working with us and actually want us to succeed. In fact, they want us to step up and do even more for them. It's my observation that Cognizant is one of those rare B2B organizations that is a so-called love brand. The reservoir of client trust we've built over the years is one of our most distinctive assets. And third, the company is brimming with talented and engaged associates around the world. Our associates are driven to grow and develop new capabilities and deeply skilled in our portfolio of solutions and in how to apply them to help our clients thrive in a digital economy. In summary, the leadership team and I are fully aware that we have a multi-year project ahead of us. My optimism about Cognizant's future is pragmatic and comes from the winning spirit of our associates around the world who are passionate about contributing to the long-term success of our clients. Notwithstanding a backdrop of macro demand uncertainty that gives us cause for prudence, I'm convinced that much of what we need to do to increase Cognizant's competitiveness is within our own control. A relentless focus on growth has defined Cognizant's performance since its founding a quarter century ago, and that determination and focus are as strong as ever. We're determined to unlock the organization's growth potential and return Cognizant to its historical position of being the bellwether in the IT services industry. With that, it's my pleasure to turn the call over to Karen, who will give you an update both on our operational and financial performance, as well as a view as to how we will see the fourth quarter. Karen.