Cognizant Technology Solutions Corporation

Ladies and gentlemen, welcome to the Cognizant Technology Solutions second quarter 2022 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. A confirmation tone will indicate your line is in the question queue. You might press star two 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 the star keys. Thank you. I would now like to turn the conference over to Mr. Tyler Scott, Vice President, Investor Relations. Please go ahead, sir. You may begin your presentation.

Thank you, operator, and good afternoon, everyone. By now, you should have received a copy of the earnings release and the investor supplement for the company's second quarter 2022 results. If you have not, Copies are available on our website, cognizant.com. The speakers we have on today's call are Brian Humphreys, 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 Humphries. Please go ahead, Brian.

Thank you, Tyler. Good afternoon, everyone. I'd like to comment on several topics today, notably our second quarter performance, the demand and pricing environment, and labor market dynamics. Let's start with our second quarter performance, which was balanced. Second quarter revenue was $4.9 billion, up 9.5% year over year in constant currency. Growth was led by digital. Second quarter operating margin was 15.5%, up 50 basis points sequentially, in line with our expectations. Financial leverage driven by sequential revenue growth, disciplined expense management, currency benefits, and the optimization of pyramid shoring and fulfillment helped offset the impact of attrition and labor cost inflationary pressure. Our industry segment performance remained largely consistent. Financial services grew 5.1% year over year in constant currency, led by insurance growth. This includes a negative impact of 190 basis points from the exit of Samlink. We continue to make progress, strengthening client relationships and financial services Earlier in the second quarter, I visited clients in Germany and celebrated a new logo win with Zurich Insurance Germany. Cognizant will help them simplify, modernize, and manage their enterprise application landscape by establishing joint DevOps teams, working to extend the insurer's AI, data, software engineering, and cloud capabilities. In insurance, CCT Intelligence Solutions, whose SaaS platform powers the property and casualty insurance industry, asked for our help in enabling their cloud transformation program. We led with our enterprise DevOps and cloud transformation consultancy and partnered with Microsoft to present a comprehensive solution. This prompted the client to also select us to build next-generation analytics and telematics solutions that are expected to be key to their long-term leadership. In the second quarter, we combined our healthcare and life sciences operating segments into a single operating segment called Health Sciences, and natural evolution given the market conversions across these industries. Health sciences grew 7.6% year-over-year in cost and currency, with growth driven by pharmaceutical clients and sustained momentum in our Triseto product portfolio. Commonwealth Care Alliance, an integrated care system serving over 60,000 members across numerous U.S. states, illustrates our momentum in Triseto. Our end-to-end business process innovation, powered by Trosetta Solutions and a BPAS engagement, is fully integrated from enrollment and billing through claims. Through our partnership, Commonwealth Care now has the tools needed to compete in the digital health ecosystem and support value-based, personalized care for its members. We've also signed a new multi-year agreement with Organon, a global women's health company, to help improve the delivery of healthcare products and crucial medicinal supply chain management. will help Oregon on scale its healthcare business by delivering full-stack industrial technology support for its global pharmaceutical manufacturing sites in the UK, Netherlands, Belgium, and Indonesia. We continue to see excellent growth in products and resources, where revenue grew 11.6% year-over-year in constant currency, driven in part by strength among automotive, logistics, retail, and consumer goods clients. As a strategic partner for digital, We're helping Albertson's companies, a $70 billion grocery retailer, make their move to a cloud-based infrastructure model, enabling innovation and improved customer experiences, both in-store and across last-mile delivery. In communications, media, and technology, we had another quarter of excellent growth. Revenue grew 19.5% year-over-year in constant currency, driven by technology clients and new client acquisition. DocuSign is an example of a new logo win, They selected Cognizant as the preferred partner for global customer support operations across all products and services from their flagship e-signature product to newer contract lifecycle management products. DocuSign turned to us because of the distinctive solution proposed by our intuitive operations and automation practice, including cutting-edge omni-channel customer support and outcome-based commercial models. A quick word on a recently announced organizational evolution. In July, we announced a combination of our practice areas with delivery practices, which simplifies our model by bringing cognizance in line with industry norms. This enables us to have end-to-end accountability across four integrated practices, from vision, roadmap, offerings, and capabilities, including M&A and post-merger integration, through to pre-sales, solutioning, and delivery. I believe this will assist our industry teams to be more successful with our clients as we sell solution and deliver client outcomes. I also believe that our industry capabilities provide differentiation and we can unlock value for clients at the intersection of industry use cases and technology. Moving now to the demand and pricing environment. While we are carefully monitoring the potential impact of a worsening economy on our pipeline, to date we've not seen any significant slowdown for IT services demand. That said, as we serve some of the largest clients in the world, we are aware that should they see slowing earnings growth, non-essential projects or those with longer ROI may be paused. I'm confident that the breadth of our portfolio enables us to serve our clients' needs for higher levels of agility, innovation, resilience, and indeed efficiency. So regardless of what the coming quarters bring, our value proposition to clients remains. More generally, Digital transformation has become so essential and foundational to most companies, regardless of their industry, that despite some macro demand uncertainty in the short term, I remain optimistic on IT services' growth prospects in the medium to long term. In fact, the bigger challenges we are faced with as an industry are the demand and supply imbalance on key digital skills, elevated attrition, and labor cost inflationary pressure. I would like to thank our associates around the world who've been working hard to navigate these challenges, all whilst trying to optimize fulfillment and pricing. Achieving the perfect balance is not always easy. And in the second quarter, while I'm pleased that we drove both year-over-year and sequential margin expansion, I suspect that our focus on fulfillment optimization and pricing marginally impacted top line performance and hurt bookings momentum. Second quarter bookings declined 3% year-over-year, below our assumptions entering the quarter. While we continue to have a robust book-to-bill ratio of approximately 1.2 times revenue on a training 12-month basis, by better balancing the factors just mentioned, we aim to accelerate bookings growth in outer quarters, whilst nonetheless achieving our committed margin expansion. Just a word now on pricing. Market pricing dynamics remain consistent. Clients, through their vendor exposure and their internal teams, are privy to demand supply imbalances across key digital skills and labor cost inflationary pressure. This coupled with the pent-up demand for digital transformation means clients are more predisposed to engage in price increase discussions. Clients are willing to pay for skills and innovation, but efficiencies, including automation and optimized delivery mix, are expected to mitigate cost increases. We continue to execute against the pricing initiative to offset labor cost inflationary pressure with benefits starting to be felt but greater impact expected in the coming quarters, recognizing that pricing power stemming from talent shortages will lag behind talent-related cost increases. Let's move now to labor market dynamics, including attrition and inflationary pressure. Second quarter voluntary attrition rose five points to 31% on an annualized basis, or 32% on a training 12-month basis. This increase was slightly above the seasonal uptake we anticipated entering the quarter, impacting second quarter revenue performance. While we have seen some signs of improvement in July resignation rates, we continue to expect elevated attrition for the remainder of the year. As I've mentioned on prior calls, attracting, retaining, and rallying our talented employees is one of our top priorities. In the past year, we've invested record levels in compensation overhauled our promotion process, invested heavily in our learning and development initiatives, and introduced a series of other measures, including educational programs and return shifts. Our internal job moves program, which facilitates ongoing upward mobility in the company, is one factor that enables us to mitigate the need for, and indeed the cost pressure of, lateral hires, all whilst improving morale. We'll also recognize how important flexibility is to our associates and have therefore communicated a hybrid model will define our approach to work. Our priority is to be a welcoming, inclusive, equitable company for everyone, no matter their work location. Our client and associate-centric company aims to strike a balance between how clients want to interact with us and the flexibility we seek, all while maintaining a focus on employee engagement, collaboration, our values, and a culture of continuous learning. I'm pleased to see that our efforts on employee engagement are working. In recent weeks, we completed our annual engagement survey that showed significant increases in our engagement scores, positioning us above industry benchmarks. In closing, as we execute our strategy, we were operating with three clear priorities. First, execute our vision to become the preeminent technology services partner to the global 2000 C-suite. Second, rally and engage your associates around the world. And third, drive profitable growth. Despite some near-term macro demand uncertainty and the challenges of navigating today's labor markets, let's not forget that we're in the early stages of what we expect to be a massive digital build-out. Thanks to our portfolio and our talented employees around the world, we believe that we will be a strategic beneficiary as companies embrace digital operating models. Finally, As we reposition Cognizant towards selling, solutioning, and delivering industry-aligned solutions, enabled by targeted advisory capabilities, our margin potential will be strengthened in line with our brand repositioning to higher value services. 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. Jan, over to you. Thank you, Brian, and good afternoon, everyone. While Q2 revenue growth was slightly below the midpoint of our guidance range, we delivered sequential margin expansion in line with our expectation. While continuing to invest into our talented people, we remain focused on profitable revenue growth. Moving on to results, Q2 revenue was $4.9 billion, representing an increase of 7% year-over-year, or 9.5% in constant currency. Year over year growth includes approximately 110 basis points of growth from our recent acquisitions and a negative 60 basis points impact from the sale of Samling completed February 1st. In Q2, digital revenue as reported grew 13% year over year and included FX headwinds of approximately 250 basis points consistent with the total company. At quarter end, Digital represented approximately 50% of total revenue, up three points from the prior year period. In addition to the FX headwinds, slowing of digital growth reflected lower inorganic contribution and elevated attrition, in particular in North America. Despite these headwinds, we were pleased with the growth across our digital battlegrounds, which outpaced the total digital growth. As Brian mentioned, Q2 bookings declined 3% year over year. This resulted in trailing 12 months bookings of $23.2 billion, which represented a book to bill of approximately 1.2 unchanged from Q1. Despite the softer than expected growth, we continue to believe this book to bill provides us a healthy opportunity to support our revenue growth outlook for 2022. We expect to improve bookings growth in the quarters ahead. Moving on to segment results for the second quarter, where all growth rates provided will be year over year in constant currency. Financial services revenue increased approximately 5%. Q2 growth included a negative 190 basis points impact from the sale of our same length subsidiary. Our recovery within financial services remains largely in line with our expectation. driven by continued strength in our North America regional banking portfolio, growth in the UK, and steady performance within insurance globally. Health sciences revenue increased approximately 8%, driven by demand for digital services among pharmaceutical companies. Demand among healthcare clients was consistent with last quarter. Momentum continued in our integrated software solutions. Products and resources revenue increased approximately 12% driven by growth across all segments and included approximately 260 basis points contribution from recently completed acquisitions. This compares to the approximately 500 basis points contribution we reported in Q1 of this year. Based on the current portfolio of closed acquisitions, we expect the inorganic contribution to be immaterial to segment performance beginning in Q3. Communications media and technology or CMT revenue grew approximately 20%, primarily organically, including growth from new clients. This reflects growing demand for data services and our work with leading digital native clients. We also continue to experience strong demand for our intuitive operations and automation services, which includes our BPO business. From a geographic perspective in Q2, North America revenue grew 9% year-over-year. Growth was led by CMT and life sciences clients. Our global growth markets, which includes all revenue outside of North America, grew approximately 12% year-over-year in constant currency, which included a negative 240 basis points impact from the sale of SAMLINK. Growth was led again by the UK, which grew 25%, and included strong double-digit growth within financial services, including public sector science, products and resources, and CMT. We continue to see significant opportunities for growth in our GGM business and do not believe that we are hitting our full potential yet. Now moving on to margins. In Q2, our GAAP and adjusted operating margins were 15.5% as there were no non-GAAP adjustments in the quarter. On a year-over-year basis, operating margin increased by approximately 30 basis points in line with our expectations. This included improvement in gross margin, driven in part by a balanced execution and our focus on profitable revenue growth. We also experienced a benefit from the depreciation of the rupee against the dollar and a modest benefit from our recent pricing initiatives. Additionally, We were pleased with the SG&A leverage we drove in the quarter. Our GAAP tax rate in the quarter was 24.2% and adjusted tax rate in the quarter was 22.2%, which benefited from a discrete tax benefit related to our un-repatriated accumulated foreign earnings driven by the depreciation of the rupee. Q2 diluted GAAP EPS was $1.11 and Q2 adjusted EPS was $1.14, up 14% and 18% year over year, respectively. Now turning to the balance sheet. We ended the quarter with cash and short-term investments of $2.3 billion, or net cash of $1.7 billion. Free cash flow in Q2 was $485 million, representing approximately 84% of net income, in line with our expectation. This brings year-to-date free cash flow to $671 million. DSO of 74 days increased by two days sequentially, driven in part by seasonality, and by three days year-over-year. We expect to improve DSO in the second half of the year. During the quarter, we repurchased 4 million shares, so $300 million, under our share repurchase program. and returned $141 million to shareholders through our regular dividend. This brings total capital returned to shareholders through share repurchases and dividends to over $1 billion through the first half of 2022. Turning to guidance. Our outlook for the remainder of the year assumes that we will continue to balance margin performance and revenue growth. For Q3, we expect revenue in the range of 4.8% $98 billion to $5.03 billion, representing year-over-year growth of 5% to 6%, or 7.5% to 8.5% in constant currency. Our guidance assumes currency will have a negative 250 basis points impact, as well as an inorganic contribution of approximately 50 basis points, which reflects the lower than anticipated M&A activity compared with our assumptions in prior full-year guidance. For the full year, we are lowering the midpoint of our constant currency revenue growth guidance by about one point, which reflects in part the impact we have had while navigating the current industry supply-demand imbalances, elevated attrition, and softer-than-expected hiring, particularly in North America. However, we are maintaining our margin expansion guidance which reflects prioritization of profitable growth, pricing initiatives, and the rigor that we have put around SG&A. Of full-year revenue, we still expect inorganic growth to contribute approximately 100 basis points to growth, unchanged from prior guidance. This assumes an immaterial contribution from future unannounced acquisitions in Q4. Our reported revenue outlook now assumes a negative 220 basis points impact from currency versus 180 basis points previously. This leads to a revised reported revenue guidance in the range of $19.7 to $19.9 billion, representing 6.3 to 7.3% growth, or 8.5 to 9.5% growth in constant currency. This compares to our prior guidance of $19.8 to $20.2 billion, 7.2 to 9.2, or 9 to 11% in constant currency. Our longer-term capital allocation framework is unchanged. Today's uncertain macroeconomic backdrop has the potential to create a mismatch of valuation expectations between buyers and sellers, as well as challenging synergy assumptions. Despite these dynamics, our pipeline remains active and we expect to announce deals towards the end of this year. However, these factors have led us to deploy less capital than anticipated on M&A. Therefore, we are revising our capital allocation plans for the remainder of 2022. We now expect to return at least $1.2 billion to share repurchases for the full year, up from our commitment of at least $600 million last quarter. As always, This remains subject to market conditions and other factors. Given the strength of our balance sheet and expected free cash flow generation, we do not expect liquidity will restrict our ability to execute against our M&A pipeline for the remainder of the year. As I mentioned earlier, our adjusted operating margin outlook is unchanged, and we continue to expect approximately 20 to 30 basis points of expansion versus Our outlook for operating margin continues to assume industry supply-side constraints and elevated attrition for the remainder of the year. Headwinds to operating margin include increased compensation costs, C&E, and a return to office cost, which we expect to offset through delivery efficiencies, digital revenue mix, pricing, and SG&A leverage and discipline. Our guidance assumes continued sequential margin expansion in Q3 before the impact of our annual merit cycle in Q4. Our full year outlook assumes interest income of approximately $35 million versus $25 million previously, reflecting higher interest rates. Based on our increased share repurchase activity, we now expect average shares outstanding of approximately $519 million versus 522 million shares previously. We also now expect a tax rate of 24% to 25% versus 25% to 26% reflecting lower year-to-date performance. This leads to our full year adjusted EPS guidance of $4.51 to $4.57, up approximately 9% to 11% year-over-year This compares to $4.45 to $4.55 previously. Finally, we are still targeting full year free cash flow conversion of approximately 100% of net income.