Cognizant Technology Solutions Corporation

Ladies and gentlemen, welcome to the Cognizant Technology Solutions second quarter 2021 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 any time, please press star 1 on your telephone keypad. A confirmation tone will 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 for you to pick up your handset before pressing the star keys. Thank you. I would now like to turn this conference over to Mr. Tyler Scott, Vice President of Investor Relations. Please go ahead, sir. You may begin.

Thank you, Operator, and good afternoon, everyone. By now, you should have received a copy of the earnings release and investor supplement for the company's second quarter 2021 results. If you have not, copies are available on our website, cognizant.com. The speakers we have on today's call are Brian Humphries, Chief Executive Officer, and Jan Siegmund, 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. With that, I'd like to turn the call over to Brian Humphreys. Please go ahead, Brian.

Thank you, Tyler. Good afternoon, everybody. Against a challenging labor market backdrop, and the recent humanitarian crisis in India, we executed well in the second quarter, allowing us to deliver significant upside to our revenue guidance. Second quarter revenue of $4.6 billion represented growth of 15% year-over-year or 12% in constant currency. I'm grateful to our teams across the world for their unflagging dedication to consistently meeting our promises to clients. Thanks to the professionalism of all our associates, we had no major disruption to client service delivery from the second wave of the pandemic in India. We continue to execute against our previously announced Operation C3, which includes our vaccination drive across the 11 cities where Cognizant does operations in India. To date, we've administered or reimbursed over 160,000 vaccines to associates or their families' independence. I'm pleased with the strength of key commercial metrics Booking's growth accelerated to 12% year-over-year in the second quarter, and our book-to-bill ratio is now 1.2 in a training 12-month basis. Qualified pipeline is significantly up, and our win rates are also up year-to-date, positioning us well for continued bookings momentum. Digital revenue growth accelerated to 20% year-over-year in the quarter. Moving to industry segments, we posted strong double-digit year-over-year constant currency growth, in communications media and technology, products and resources, and healthcare. We've achieved a double-digit CAGR over the past four years in communications media and technology and remain optimistic on our growth prospects. This industry is now home to some of our largest clients. Within products and resources, we continue to post excellent growth in manufacturing, logistics, energy, and utilities. Meanwhile, both retail and consumer goods, and travel and hospitality posted their fourth successive quarter of sequential revenue increases and are now close to pre-pandemic revenue levels. Our healthcare business had a strong quarter with double-digit year-over-year growth in both the life sciences and U.S. payer and provider businesses. I'm delighted with our sustained momentum in life sciences, which will allow us to cross the $2 billion annualized revenue threshold later this year. As we strengthen our relationship with existing biopharma and medical device companies, our strong client references and delivery excellence are positioning us well to expand it to new logos. For example, we partnered with Beatrice, the newly formed company resulting from the merger of Mylan and Upjohn, a legacy division of Pfizer, to support their integration readiness for day one. We are now continuing our collaboration on post-murder integration services. We will continue to invest to support our clients' digital needs in the life sciences business. Last week, we agreed to acquire TQS Integration, a privately owned, Ireland-based global industrial data and intelligence company that will enhance our smart manufacturing offerings and build upon our successful acquisition of Zenith Technologies from 2019. And earlier this month, we announced a strategic alliance with global health technology leader Philips to develop end-to-end health solutions that will enable healthcare organizations to improve patient care and accelerate clinical trials. Over the past two years, we focused significant effort on reinvigorating the U.S. payer and provider businesses. These efforts have started to bear fruit. During the second quarter, we expanded our existing partnerships with large payer clients and added new logos in the provider market. The TriZetto product business is highly strategic to our healthcare business. Following some weakness post the 2014 acquisition, we spent considerable energy soliciting client feedback and refreshing the product roadmap over the last two years. We are now seeing growing momentum in the business. Annual growth rates in the TriZetto product business doubled in 2020 over 2019 and are on track to double again in 2021 following double-digit revenue growth in the first half of the year. Turning now to financial services, which grew 5% year over year in constant currency, both the banking and insurance businesses grew year over year and sequentially. In banking, which is most of the financial services business, we have sharpened our focus on the highest potential client relationships over the past 18 months. We've refreshed now about half of our client-facing teams, bringing in seasoned industry talent with an emphasis on executive engagement and selling and delivering business outcomes in collaboration with the financial services partner ecosystem. While we are making progress in our client engagement strategy and have seen sustained momentum in regional banks, banking results continue to be hindered by ongoing revenue erosion in large global banks. As such, while we expect full-year financial services revenues to grow modestly, the repositioning of the business continues. Before discussing the macro demand environment, I would like to acknowledge the progress we've made in our BPO business, which we call digital business operations. Two years ago, we made the decision to exit certain non-strategic elements of the content moderation business that had been a meaningful contributor to growth. This decision impacted a growth trajectory of DBO and required us to reposition the business. Two years on, we've now successfully completed the exit of the content moderation business, and as of the third quarter, revenue compares will be like for like. I'm pleased with the revised strategic direction of digital business operations, which focuses on automation, analytics, and consulting, as well as platform-based and core business process operations. Year to date, we've seen double-digit revenue growth in digital business operations, And we expect to sustain this growth in the coming years, driven by strong results in modern BPO segments like digital natives and intelligent process automation, and by our leadership position in VPaaS within the healthcare segment. A recent example of our client momentum is Johns Hopkins Healthcare, who turned to us to transition their Medicaid and commercial lines of business from legacy platforms and operations to our leading VPaaS solution. We'll be providing a modern, scalable cloud-based platform to enable Johns Hopkins Healthcare to be a more robust, flexible organization that can deliver better, more affordable patient outcomes. Let's turn now to macro demand, which is particularly robust as clients modernize their legacy environments, embrace the cloud, and invest in innovation. We continue to believe that the next phase of digital is about transforming processes to become agile, intelligent, and automated. and always with an eye on customer experience. Hyper-personalization is fueling significant demand in analytics, AI, and ML. Given strong demand and our bullish outlook on the industry, we are committed to meaningfully scaling our headcounts over the coming quarters. However, this macro demand backdrop has also created a demand-supply imbalance in key skills and has meaningfully increased industry attrition. As we noted in last quarter's remarks, we expected attrition to go up sequentially in Q2, and it did. Second quarter voluntary attrition reached 29% on an annualized basis, or 18% on a training 12-month basis. As a reminder, our attrition metric captures the entire company, including trainees and corporate, across both IT services and BPO. Against this backdrop, we continue to take a series of actions to reduce attrition, including compensation adjustments, job rotations, reskilling and promotions, and a host of associate engagement activities. Fortunately, we meaningfully increased our recruiting capacity over the last six months as we anticipated the spike in attrition following the V-shaped demand recovery in the second half of 2020. Our human resources team have done a remarkable job helping us mitigate the impact of elevated attrition through comprehensive hiring, onboarding, and skilling programs. In fact, we now expect to hire approximately 100,000 laterals in 2021 and to train close to 100,000 associates. In addition, we expect to onboard approximately 30,000 new graduates in 2021 and make 45,000 offers to new graduates in India for 2022 onboarding. Over recent years, we've been methodically shifting our revenue mix to digital. which now accounts for more than 44% of our revenue. Since 2019, we've invested more than $2 billion in mergers and acquisitions to accelerate our digital capabilities. While the impact of recent acquisitions has reduced Q2 company margins given diligence and integration costs and acquired company margin dilution, it has nonetheless been the right thing to do. These investments have changed the growth profile of Cognizant by shifting our businesses to higher growth categories. and reducing our exposure to non-digital categories that have declined in recent years. Today, I wanted to spend a moment addressing some of our progress against our targeted digital battlegrounds, including IoT, digital engineering, and cloud. Our IoT business has scaled rapidly, and revenues are now expected to exceed $600 million in 2021, almost twice the size of what it was in 2019. Cognizant was recently ranked number one in the managed IoT services category in ISG's 2021 IoT services evaluation for both the US and Europe. Our digital engineering business is now at a $1.2 billion annual run rate, growing 30%, making it one of the largest digital engineering businesses in the world. In June, Cognizant was named a leader in Everest Group's Peak Matrix for Software Product Engineering Services 2021 report. We've also made tremendous headway in our cloud business. Seven of our acquisitions over the past 18 months have been cloud-related. As you may know, Gartner, in its magic quadrant for public cloud infrastructure managed services providers, elevated Cognizant from a niche provider player in 2018 to challenger in 2019 and to leader in 2020. We now have three cloud-focused business groups, one for Microsoft, another for AWS, and a third most recently for Google, each supported by specialized cloud experts and solution architects. For example, we've been recently engaged with Microsoft's industry clouds in areas like financial services, healthcare, and retail. In the past two years, thanks to our ongoing market momentum, the acquisitions of New Signature, Katino, and Tent Magnitude, and the formation of our Microsoft Business Group, we have meaningfully changed our ranking to become one of Microsoft's leading global system integration partners. Our commitment to the partnership and focus on technical intensity is demonstrated by more than 100% year-over-year growth in our Microsoft Cloud certifications. Our success in extending our portfolio has not only made us more competitive, but has encouraged more clients to engage us to execute their transformation agendas. This positions us to take full advantage of our client base by enabling us to upsell and cross-sell in our existing accounts and enables us to get new logos by leading with digital. For example, Gilead Sciences selected us to lead a body of work related to IT business transformation, as well as development of an enhanced security and compliance posture. We will utilize our deep life science industry knowledge, augmented by recent acquisitions like Zenith Technologies and Collaborative Solutions, along with our proprietary legacy modernization framework and robust automation capabilities to support this work. Our aim is to accelerate the company's technology transformation and further enhance its digital capabilities. In another example, given our advanced capabilities in digital automotive, engineering R&D, and smart connected mobility, Qualcomm Technologies, one of the world's foremost semiconductor and connectivity solutions companies, turned to us to build a reliable cloud agnostic connected vehicle management solution. The aim of this integrated platform is to connect vehicular onboard applications, manage car to cloud operations, and work across nearly every OEM vehicle platform and its cloud infrastructure. Lastly, building exceptional digital experiences is of increasing importance to clients who sometimes struggle to connect the dots between the experience itself and the underlying business functions. With our extended portfolio, we're now able to orchestrate software, data, platforms, and programs to transform high-value interactions into personalized experiences that drive business results. A great example of this is how we're now partnering with NBC to reimagine their customer experience, creating direct consumer commerce strategies, driving attendance to their theme parks, and supporting their marquee event, the 2021 Summer Olympic Games. In closing, I've been in the CEO role now for more than two years, and I see a new caucus of taking shape. Our solution portfolio is stronger than at any time in our history. This has changed the way clients and partners perceive us and helps us deliver differentiated business outcomes. We are bullish on the industry and our prospects within it. We are well positioned to capitalize on digital transformation market trends, which are accelerating, and we have an enormous opportunity in our international markets. But we are in one of the hottest job markets in many years and expect elevated attrition to remain a factor across the industry in the coming quarters. our recruitment and skilling programs, as well as targeted actions to offset margin headwinds stemming from the industry's talent shortage, provide us confidence in our outlook for the year. With that, I'll turn the call over to Jan, who will cover the details of the quarter and our financial outlook before we take your questions. With that, over to you, Jan. Thank you, Brian, and good afternoon, everyone. Our Q2 revenue was $4.6 billion representing growth of approximately 15% or 12% in constant currency. Revenue was $125 million above the high end of our guidance range, driven by continued demand for digital, which grew 20% and represented 44% of total revenues. Year-over-year revenue growth also includes approximately 390 basis points of growth from our recent acquisitions, and benefited from an easier compare to Q2 2020, where our revenues were impacted in the early months of the pandemic and by the ransomware attack in April 2020. Moving on to segment results, where all growth rates provided will be year-over-year in constant currency. Financial services revenue increased approximately 5% in line with our expectations. We continue to make progress as we reposition this business and observe a strong improvement in the pipeline. We still expect a pace recovery through the remainder of the year. Healthcare revenue increased approximately 13%, again driven by strong performance in both our healthcare payer and life sciences businesses. Revenue growth within our healthcare business was primarily organic. and we continue to see strong demand for our integrated payer software solutions and improving fundamentals in our provider business. As Brian mentioned, we remain very pleased with the growth in our life sciences business. Products and resources revenue increased approximately 18%, driven by the fifth consecutive quarter of double-digit growth in manufacturing, logistics, energy, and utilities. Segment growth included approximately 600 basis points from inorganic revenue. As Brian mentioned, we also experienced growth in retail consumer goods and travel and hospitality, driven in part by the lapping of the pre-pandemic compares. There are early signs of stabilization within these sectors most impacted by the pandemic, but we continue to monitor closely. Communications, media, and technology revenue grew 18%, of which approximately half of the growth was attributable to recent acquisitions. This growth was partially offset by a negative 190 basis points impact from our exit of certain portions to our content services business. Overall, we are very pleased with the growth of our core portfolio. Now moving on to margins. In Q2, our GAAP and adjusted operating margin were both 15.2%. On a year-over-year basis, adjusted operating margin improved approximately 110 basis points, primarily reflecting the savings from our cost initiatives in 2020 and the impact from the pandemic and ransomware attack in Q2 2020. This year-over-year benefit was offset in part by SG&A investments, including those intended to drive and support organic revenue growth, as well as the negative impact on margin of recently completed acquisitions and costs related to the modernization of our IT core and security infrastructure. In addition, we anticipate continued cost pressure from our elevated attrition, which includes higher recruiting costs, lateral higher wages, and subcontractor costs. Our GAAP tax rate in the quarter was 26.5%, and our adjusted tax rate was 25.4%, in line with our expectations. Diluted gap EPS was $0.97, and adjusted diluted EPS was $0.99. Now turning to the balance sheet. We ended the quarter with cash and short-term investments of $1.9 billion, or $1.2 billion net of debt. Free cash flow in Q2 was $466 million. This included a payment from the settlement with two of the three customers that were part of the proposed customer engagement exit we announced in our fourth quarter 2020 earnings. Excluding this one-time payment, free cash flow would have been approximately 100% of net income. The payments made this quarter were in line with our prior expectations and resulted in no impact to our earnings in Q2. Overall, we were pleased with the outcome of the settlement which includes a continued commercial relationship with both customers. Negotiations with the third client are ongoing and constructive. DSO of 71 days increased by one day sequentially and has improved from 77 days in the prior year period. During the quarter, we repurchased 4 million shares for $296 million at a weighted average price of approximately $74 per share. At the end of June, we had $2.3 billion remaining under our share repurchase authorization. We also spent cash of approximately $350 million on acquisitions and $127 million for our regular quarterly dividend. Turning to guidance. For Q3, we expect revenue in the range of $4.69 to $4.74 billion. representing year-over-year growth of 10.6% to 11.6% or 10 to 11% in constant currency. Our guidance assumes currency will have a favorable 60 basis points impact and inorganic contribution of approximately 320 basis points. For the full year, we now expect revenues of $18.4 to $18.5 billion, representing 10.2 to 11.2 percent growth or 9 to 10 percent in constant currency. This compares to our prior guidance of 7 to 9 percent growth as reported or 5.5 to 7.5 percent in constant currency. Our outlook assumes currency will have a favorable 120 basis points impact and includes approximately 320 basis points contribution from inorganic revenue. Our outlook assumes continued momentum across healthcare, CMT and products and resources while we continue to expect a pace recovery in financial services over the next couple of quarters. Moving on to margins, we expect full year adjusted operating margin to be approximately 15.4%, the midpoint of our prior guidance of 15.2 to 15.7%. As I mentioned earlier, Elevated attrition is leading to increased costs in certain areas. We are also continuing to fund investments in our people, including compensation, quarterly promotions, retention and training. We expect these costs will weigh on our results for the next several quarters as management remains keenly focused on addressing our high attrition levels through a comprehensive set of initiatives. We continue to expect SG&A growth for the remainder of the year, driven in part by the impact from our M&A activity. However, we're slowing the pace of growth in some areas, not directly related to our strategic initiatives, to mitigate some of this cost pressure. This leads to our full-year adjusted EPS guidance, which is $4 to $4.06, compared to $3.90 to $4.02 previously. Our full-year outlook assumes interest income of $25 to $30 million compared to $20 to $30 million previously. Our outlook assumes average shares outstanding of approximately $528 million compared to $530 million previously, and a tax rate of 25 to 26%, which is unchanged from our prior outlook. Finally, we continue to expect free cash flow will represent approximately 100% of net income for the full year. We remain committed to our balanced capital deployment strategy and returning at least 50% of free cash flow to shareholders through dividends and share repurchases. Before opening the call for questions, I wanted to let you know that we are planning to hold an investor briefing in the fall during which Brian and I will provide a review of our strategy and an update on our progress over the last two years. We will also provide our multi-year financial framework. Please keep an eye out and save the date in the coming weeks. With that, we will open the call for your questions.