David Nelson – Vice President, Investor Relations and Treasurer Francisco D'Souza – Chief Executive Officer Gordon Coburn – President Karen McLoughlin – Chief Financial Officer.
Bryan Keane – Deutsche Bank AG Edward Caso – Wells Fargo Securities, LLC Mayank Tandon – Needham & Co. LLC Lisa Ellis – Sanford C. Bernstein & Co.
LLC Joseph Foresi – Janney Montgomery Scott LLC Keith Bachman – BMO Capital Markets David Togut – Evercore Partners Sara Gubins – Bank of America Merrill Lynch Jason Kupferberg – Jefferies LLC Brian Essex – Morgan Stanley Glenn Greene – Oppenheimer & Co. Inc. Steven Milunovich – UBS Investment Bank Moshe Katri – Cowen and Company, LLC.
Ladies and gentlemen, welcome to the Cognizant Technology Solutions Third Quarter 2014 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question-and-answer session. (Operator Instructions) Thank you.
I would now like to turn the conference over to David Nelson, Vice President, Investor Relations and Treasurer at Cognizant. Please go ahead, sir..
Thank you, and good morning, everyone. By now, you should have received a copy of the earnings release for the company's third quarter 2014 results. If you have not, a copy is available on our website, cognizant.com.
The speakers we have on today's call are Francisco D'Souza, Chief Executive Officer; Gordon Coburn, President; and Karen McLoughlin, Chief Financial Officer. Before we begin, I would like to remind you that some of the comments made on today's call and some of the responses to your questions may contain forward-looking statements.
These statements are subject to the risks and uncertainties as described in the company's earnings release and other filings with the SEC. I would now like to turn the call over to Francisco D'Souza. Please go ahead, Francisco..
Thank you, David, and good morning, everyone. Thanks for joining us today. I'll start with the highlights of our third quarter results and outlook for the rest of the year. And also take some time to share with you some of the broader industry trends that we’re seeing.
Gordon will then discuss our detailed operating results and Karen will provide further details on our financial metrics and guidance before we open up the line for Q&A. Our results this quarter was solid and slightly ahead of the guidance we provided to you at the end of last quarter. For the third quarter, we delivered revenue of $2.58 billion.
As expected our non-GAAP operating margin was within our guided range of 19% to 20%. We now expect full year 2014 revenues to be between $10.13 billion and $10.16 billion, reflecting our performance this quarter and our improved outlook for the reminder of the year. This provided guidance excludes any impact of the pending TriZetto acquisition.
As you are aware, last quarter we reported some weakness in certain clients and longer than expected sales cycles for certain large integrated deals. We see the impact of those two factors abating and expect them to no longer be a concern as we go into next year.
We’re confident in our strategy and as we start planning for 2015 we find that our run better, run different value proposition is firmly in step with the needs of the market. This was first evident in industries such as healthcare and financial services.
We can now see it playing out across all of the industries that we serve, as it’s apparent in the number of end-to-end integrated deals in our pipeline today, as well as in the demand for solutions based on new digital technologies. Let me explain this a little bit more.
Many quarters back we saw signs of significant technology shift and a corresponding business model change driven by the ongoing volatility in major economies on one hand and the advent of new digital technologies on the other.
We said that the only way for businesses to adapt would be to simultaneously execute on efficiency and scale with existing systems, while driving business innovation through newer technologies. We refer to this as the dual mandate. And one way to understand it better is through the lens of what’s happening in the healthcare industry.
Although I’m going to speak specifically about healthcare here, we see the effects of the dual mandate playing out across multiple industries and geographies. Healthcare, especially in the U.S.
is seeing significant disruption on account of regulatory reforms, aging populations, new technologies, greater need for transparency and increasing price competition.
As a result healthcare clients are increasingly demanding end-to-end solutions that help them drive efficient operations, while investing for future growth to deal with the challenges facing the healthcare industry today.
We believe our acquisition of TriZetto and our transformative deal with Health Net, the two biggest transactions in our history bring us significantly closer to being able to create and provide this type of end-to-end solution in the healthcare industry. With TriZetto platforms serving half of the U.S.
population and a quarter of the providers in the United States, coupled with the operating expertise and technology of Health Net, there’s really an opportunity here for us to reinvent healthcare in very fundamental ways.
With an underlying software platform running on infrastructure provided by Cognizant, delivered over the cloud, combined with the services required to run the business process, we will be able to offer a fully-integrated service to our clients and charge them on a per transaction or per user basis.
On one side of the dual mandate solutions like these allow us to work with healthcare peers and providers to optimize existing G&A spend, while improving the quality of their service.
And on the other side of the dual mandate we’re actively working with healthcare clients on digital technology based innovation, creating for them increased agility in launching new products and participating in new markets to drive new sources of revenue.
The great example of how by enabling clients to be more efficient in their use of capital resources we are creating new opportunities for innovation in products and services for the healthcare industry.
We have spoken at length about Health Net and TriZetto in previous calls, and Gordon and Karen will provide updates for each of them in a few minutes. Before I close, I would like to spend a few minutes talking to you about the demand environment as reinforced by our client conversations from our recently concluded Cognizant Community Event.
As you know, we have invested over the past three years to build our digital capabilities, and as previously indicated have seen significant traction of our social, mobile, analytics, and cloud offerings with clients. Across industries, we are seeing business reinvention, driven by the rapid consumerization of technology.
This is bringing the physical and the digital worlds close together, and as a result, almost every physical process is being instrumented and digitized. Against this backdrop, we see four emerging needs and corresponding opportunities for Cognizant across the industries. Let me catch upon them briefly.
First, we are seeing an integration of SKUs combining new skills like data science, design, instrumentation, and embedded sensors, with traditional skills like consulting and technology. These SKUs then work closely with client teams to produce rapid, short cycles of innovation.
Second, distilling and applying meaning from the digital data surrounding every person, process, organization, and device, or what we call a Code Halo, is leading to an urgent demand for interdisciplinary skills around data science, artificial intelligence, and mathematics.
Third, digital technologies are becoming prevalent throughout our clients businesses, which is resulting in opportunities to expand beyond the CIOs office to departments such as marketing.
And finally, we see a need for deep, scalable expertise and foundation of technologies of social, mobile, analytics and cloud, which when combined with appropriate security models will be critical for enabling clients to realize their digital ambitions.
In order to quickly realize value from digital technologies, we are working across our business units and bringing together strategy and industry knowledge, design, process thinking, and technology and data science.
In the coming quarters, we will talk in more detail about our go-to-market model for our digital business, but we are making investments in all of the areas, I just spoke about. This quarter we acquired Cadient, a full-service digital marketing agency that caters to the nuances of the life sciences industry.
Gordon will share more details on that in a few minutes. I'm very excited about the new areas of growth and ways of working, which I believe fits very well with our entrepreneurial culture. With that, I will now hand it to –hand the call over to Gordon to share more about our performance, and to Karen to provide financial details.
I will be back for the Q&A.
Gordon?.
Thank you, Francisco. Before I get into the details of the quarter, I'll first provide some additional color on the current demand environment, update you on the large transformational deal with Health Net, and the status of planning for integration with TriZetto, as well as briefly discuss our recent acquisition of Cadient.
Similar to what we indicated three months ago, the overall demand environment remains strong. This is reflected in our strong order pipeline and our record number of new hires during Q3. We are pleased to have achieved these results slightly ahead of our Q3 revenue guidance and our confident in our increased guidance for the full year.
As expected, the client specific weakness and delays in project ramps that we spoke about last quarter, will continue to impact results through the remainder of this year, but as Frank said, this should abate as we finish the fourth quarter.
Last quarter, we spoke about our transformative engagement with Health Net, which is the largest contract value in our history. As recently announced by Health Net, the contract has been signed.
Health Net has begun the process of securing regulatory approval and we anticipate that we will begin to ramp up this engagement once regulatory approvals are completed in the first-half of next year. Moving onto TriZetto. We are preparing to close the $2.7 billion acquisition of TriZetto.
Karen will comment on the financing of this acquisition in a few minutes. This transaction is subject to customary closing conditions, but I can share with you that detailed integration plans are well underway within our healthcare practice, as well as at the corporate level.
Importantly, the response to the pending TriZetto acquisition from clients in both healthcare and our other industry verticals has been positive and is generating excitement around what this can mean for their businesses.
Finally, our recent announcement of the acquisition of Cadient further expands the scope of digital marketing capabilities we can bring to our clients. Cadient is a full-service digital marketing firm serving the life sciences industry. As Frank mentioned, we see an increasing opportunity to expand beyond the CIOs office.
And Cadient further strengthens our ability to participate in the brand marketing budgets of life sciences clients. Additionally, we fully expect to leverage the IP that comes with Cadient and pursue industry segments beyond life sciences.
From an industry perspective, our banking and financial services segment grew 2.2% sequentially and 13.4% year-over-year, driven primarily by strength in insurance, where there is growing interest in end-to-end managed services.
On the banking side, underlying demand drives from regulatory compliance, real-time risk monitoring, and fraud and trade surveillance support longer-term growth. Additionally, our financial services clients are looking to us to build and integrate SMAC solutions.
Projects to include implemented solutions to enhance the customer experience in areas such as mobile banking and card application processes, or analytics, where we provide end-to-end solutions in areas such as mortgage model implementation, monitoring and validation, or digital and multichannel analysis.
Our Healthcare segment, which consists primarily of our payor, pharmaceutical, and medical device clients, grew 1.5% sequentially, and 9.2% year-over-year.
Within the pharmaceutical sector for a second quarter in a row, we experienced above the average sequential – above the average company's sequential growth, as clients look to us to help optimize their IT applications and operations.
In addition, we are pleased with the net new business we are winning from our existing clients, as well as several new clients.
We believe that we are well positioned in the coming year in multiple areas of importance, including M&A integration on some key deals we closed for our clients – that we’ll close for our clients in the coming months and new product launches with the capabilities we acquired through the Cadient acquisition will be applicable.
To help the demand from our pharmaceutical clients and help to offset the continued softness in our payor sector, something that we highlighted in the first-half of this year.
The payor industry has taken a more cautious approach through investment this year, and specially off to a significant level of investment and tying in with public health insurance exchanges during 2013.
However, our confidence in the longer-term opportunities in the healthcare market is demonstrated by the acquisition of TriZetto and the engagement with Health Net Our regional and manufacturing segment improved sequentially up 3.6% compared to the second quarter and up 8.6% over Q3 of 2013.
On the manufacturing and logistics side, we saw good growth from both increased spend at existing clients, as well as the addition of new logos.
Clients in these industries continue to focus on solutions to drive operational efficiency by modernizing their existing systems, sampling their supply chains, and embracing SMAC solutions such as Internet-enabled devices to improve supply chain visibility and logistics operations.
Our retail practice also saw a good growth in Q3 after a slow start in the first-half of this year.
Our other segment, which include high-tech, communications, and information, media, and entertainment clients showed solid growth in the quarter, up 3.8% sequentially and 19% year-over-year, primarily driven by further penetration with our existing clients.
Let me now turn to a detailed discussion of our Horizon 2 service lines, where we continue to be pleased with the market pressure we are realizing. Our BPS practice saw continued traction during the quarter, largely on the ramp up of a number of wins in prior quarters across financial services, insurance, and healthcare.
Demand for our vertically aligned business processes such as membership enrolment and revenue cycle management in healthcare, and claims processing and mortgage services in insurance and financial services remains strong.
We believe having an industry focus BPS practice is critically important in driving future utility like delivery models based on what we refer to as BPaaS or business process as a service. Cognizant Business Consulting, or CBC, continued its pace of above-company average growth.
CBC is the key differentiator for us as we compete, win, and execute transformational engagements across various industry segments. Clients expect us to bring industry specific thought leadership to them and we do so through CBC.
Just one example, working with one of our pharmaceutical clients, CBC led a consulted approach to a large post-merger transformation – the transformation deal from sourcing and financial modeling to change management expertise and ensuring minimal disruption to clients business operations.
Today’s hyper connected world requires both sides of the dual mandate; efficiency and innovation to be brought to market in accelerated manner. And CBC's strategic focus aligns perfectly with this expectation.
We believe CBC's role will continue to grow in importance, as our clients look to our consultants to drive process – business process innovation to transform the organizations and lead the adoption of digital solutions. IT infrastructure services had another strong quarter.
We’re seeing solid demand from clients looking to simplify, optimize, and automate their infrastructure through newer delivery models or integrated solutions requiring both IT infrastructure management and application management. From a geographic standpoint, North America grew 2.7% sequentially and 11.1% year-over-year.
Revenue from Europe grew 1.3% sequentially and 13.9% year-over-year. In constant currency terms, Europe grew 2.7% sequentially. Following some client specific weakness in the second quarter, the UK grew 4.1% sequentially, or 4.8% in constant currency terms.
Continental Europe declined 2.6% sequentially and it was roughly flat in constant currency terms. We expect solid growth in the continent over the coming years. As we anticipate that the structural shift towards larger multiyear outsourcing programs drives expanded opportunities.
The rest of the world continued to show good growth of 4.4% sequentially and 18.2% year-over-year. Now, let me turn the call over to Karen to provide more details on our numbers..
Thank you, Gordon, and good morning, everyone. Third quarter revenue was $2.58 billion represented growth of 2.5% sequentially, and 11.9% year-over-year. Non-GAAP operating margin, which excludes stock-based compensation expense and acquisition-related expenses, was 19.5%, within our target range of 19% to 20%.
Non-GAAP EPS of $0.66 exceeded our previous guidance by $0.03. Consulting and technology services and outsourcing services represented 53.5% and 46.5% of revenue respectfully for the quarter. Consulting and technology services increased 5.1% sequentially, and 18% year-over-year.
Outsourcing services were flat sequentially and grew 5.7% from Q3 a year ago. During the second quarter, 35% of our revenue came from fixed price contracts, and as expected, overall pricing was stable. We closed the quarter with 1,255 active clients and added seven strategic customers, bringing our total number of strategic clients to 264.
Today, we have repurchased approximately 34.1 million shares for a total cost of approximately $1.13 billion under the share repurchase authorization of $2 billion, and have approximately $870 million remaining unutilized. Our fully diluted share count remains flat at 612.1 million shares in the quarter.
Due to our knowledge of the TriZetto announcement, we were restricted from repurchasing shares during the third quarter. Receivables were $2.1 billion, and we finished the quarter with a DSO, including unbilled receivables of 76.5 days, essentially flat with last quarter.
The unbilled portion of our receivables balance was approximately $338 million, up from $298 million at the end of Q2. We billed approximately 57% of the Q3 unbilled balance in October. The increase in unbilled receivables was primarily due to the timing of certain milestone deliverables and the ramp up of certain new long-term fixed-bid contracts.
Our balance sheet remains very healthy. We finished the third quarter with approximately $4.6 billion of cash and short-term investments, up by approximately $489 million from the quarter ending June 30, and up by approximately $1.3 billion from the year-ago period.
During the third quarter, operating activities generated approximately $583 million of cash. Financing activities were approximately $8.4 million use of cash, and capital expenditures were approximately $55.6 million during the quarter. As mentioned previously, we are preparing to close the acquisition of TriZetto.
The funding for this acquisition will come from approximately $1.7 billion of cash on hand, and $1 billion debt facility. This debt is expected to be in the form of syndicated term loan. Additionally, we anticipate securing $750 million unsecured revolving credit facility.
Let me now provide some color on our business and operating metrics for the quarter. During the quarter, we added approximately 12,300 net new hires, and ended the quarter with nearly 200,000 employees globally, approximately 187,500 of which were service delivery staff.
43% of our new hires were direct college hires, while 57% were lateral hires of experienced professionals. Annualized attrition of 15.6% during the quarter, including BPO and trainees, was down by 350 basis points from the year-ago period, and over 100 basis points from Q2 of this year.
Attrition levels are something we continue to monitor very closely, and we’re pleased by the sequential and year-over-year decline in this metric. Utilization declined on a sequential basis as we on-boarded the net new hires. Offshore utilization was approximately 72%.
Offshore utilization, excluding recent college graduates during our training program, was approximately 80% and on-site utilization was approximately 93% during the quarter. I would now like to comment on our outlook for the rest of the year. This guidance excludes any impact from the acquisition of TriZetto.
We now expect our full-year revenues to be in the range of $10.13 billion to $10.16 billion. We’re pleased that we’re able to increase guidance by, at least, $50 million, despite having to absorb a currency headwind of approximately $40 million since our previous guidance.
For the fourth quarter of 2014, we expect to deliver revenue of between $2.61 billion and $2.64 billion, including approximately $4 million of revenue from the Cadient acquisition. During the fourth quarter, we expect to operate within our target non-GAAP operating margin range of 19% to 20%.
Also for the fourth quarter, we expect to deliver non-GAAP EPS of, at least, $0.63, our non-GAAP EPS guidance excludes net non-operating foreign currency exchange gains and losses, stock-based compensation and acquisition-related expenses and amortization.
This guidance anticipates the share count of approximately 612 million shares and a tax rate of approximately 25.5%. We now expect to deliver non-GAAP EPS of, at least, $2.57 for the full year. This guidance anticipates the full-year share count of approximately 612.3 million shares and a tax rate of approximately 25.3%.
Now, we’d like to open the call for questions.
Operator?.
(Operator Instructions) Thank you. Our first question comes from the line of Bryan Keane with Deutsche Bank. Please proceed with your question..
Hi, guys. Just wanted to ask about the two things of weakness that you guys have kind of said, called out as improving.
One, I think, last year the weakness was longer sales cycles, sounds like that close, just want to get some color on what’s happened in the pipeline? And then two, client weakness, it sounds like you’re not seeing or not worrying about that as we head into 2015, so just one extra color on those two things? Thanks..
Hey, Bryan, it’s Gordon. So on longer sales cycles, those comments were related to on these very large deals, they are just more complex and they take longer, it’s really tougher to project. And we talked about three deals last quarter and those took a little longer to sign. In terms of our normal deals, sales cycles have been normal all year.
So I don’t see any change in our sales cycle from earlier in the year. But let me be clear, that our sales cycle earlier in the year on, normal deals is absolutely fine and complex deals, it takes longer, and I would expect the future complex deals, those will be – those will continue to take long and that’s baked into our planning.
In terms of client weakness, when we took our guidance down at the end of the second quarter, we pointed to – it was a handful of clients that was impacting that not overall demand environment. I think that continues to be the right statement. The overall demand environment is healthy. Those four clients – four or five clients did impact us.
The impact of that fully washes through the system by the end of Q4..
Okay. Just a quick follow-up on outsourcing still flat sequentially, I think on growth. What's the outlook in the outsourcing business and congrats on the quarter. Francisco D'Souza Sure, so the outsourcing business is alive and well.
When I think about some of the large deals that we’ve won, such as Health Net and such as the deal we won with a large high-end financial services segment, those will be heavily weighted towards outsourcing, so there is a little bit of a low there, but when I look at the pipeline of deals that I won that start to ramp up next year certainly I would expect growth in outsourcing as well..
Thanks..
Our next question comes from the line of Edward Caso with Wells Fargo. Please proceed with your question..
Hi, good morning. Can you talk a little bit about – more about Europe, particularly the variance in the sequential growth in United Kingdom versus the continent? Thank you..
Hey, it’s Frank. I think when we spoke – last quarter when you looked at the UK, we had a sequentially down quarter.
Part of that was because some of these specific client situations to which we referred last quarter were in the UK, as that as Gordon pointed out, as that starts to flush through the system the underlying growth of the UK, which we think is still – which is still help these coming, it’s showing in the numbers now.
I think the continent will continue to be – it’s a great opportunity right now. We are underpenetrated in the continent, both at Cognizant level, but as an industry, global sourcing, I think there’s still a lot of opportunity in the continent, but historically the continent has been a more – market has been more focused on discretionary spending.
And so as we see the shift from discretionary spending to our outsourcing in the continent you’ll find that that it will be somewhat lumpy and I think you saw that this quarter, but I don’t think there’s anything fundamentally to read into that beyond the normal what I think of as continental European lumpiness..
Can you talk a little bit about the success of the India-centric firms in continental Europe and getting them to embrace doing their outsourcing work in India as opposed to doing it maybe more regionally? Are you seeing a shift there and is that a factor in both your current numbers and your outlook..
I would say, we’ve said for years now that the model in continental Europe will require us to have very strong local presence, combined with a very solid near-shore delivery center and then, of course, with the global delivery model. You need all three pieces. You need a very strong local presence in country.
You need a regional delivery network and you need a global delivery – a set of global delivery locations to serve continental Europe and all three of those pieces need to be in place.
Now we feel very good about our presence in continental Europe because of that, as you know, we’ve invested very heavily both organically and inorganically to build out the local presence, going back to the acquisition that we did several years ago in Benelux of Infopulse, more recently Equinox in France and C1 in Germany.
And then, of course, we’ve also built the regional delivery network with regional centers in several locations, including our most recent regional delivery center in Spain.
We also have in the South of France and in Eastern Europe, and so on, that will continue to build out the regional delivery centers in Europe, and then, of course, the global delivery mechanism. So we feel very strong about our presence there and we think that you need all three of those pieces to succeed in continental Europe..
Thank you..
Our next question comes from the line of Mayank Tandon with Needham & Company. Please proceed with your question..
Thank you. Good morning.
I just wanted to focus on the SMAC side, what percent of Horizon 3 are SMAC today, Gordon or Frank? And then as you look at the business are you winning that from new customers or is most of the growth coming from clients where you already have very long term relationships with? And then finally on that, competitively are you seeing more niche players competing for the SMAC work or is it till the large SIs that you typically compete with for outsourcing type projects?.
Hey, Mike, it’s Gordon. So a couple of things, we’re seeing very healthy demand for SMAC and Digital within Horizon 3 and certainly that becomes the biggest component of Horizon 3, just given that’s what customers are buying today. And we have just tremendous capabilities to deliver in the SMAC and Digital area.
Who we’re doing the work for? Certainly, it’s weighted towards projects at existing customers, because we have the relationships those can kick in faster, but we are also successful at using it as a foot in the door with new clients, because clients are looking for innovative ideas in Digital and SMAC. And we have some really good thought leadership.
I’m sure many of you’ve read Code Halo book that we had published. People read that and they say come on in and talk to us at the C-Suite level.
Who do we see competing? It’s more weighted towards the fully integrated SI, but certainly there are bunch of niche players out there, so we compete with both, but when you look at the where the lion’s share of the revenue is going, it’s going to the larger SIs including us..
Great. Thank you..
Our next question comes from the line of Lisa Ellis with Sanford Bernstein. Please proceed with your question..
Hi, guys. Good morning. Hey, I have a couple of questions about TriZetto. Gordon, you mentioned that the integration plans are well underway.
Can you talk a little bit about what the plan is for continuing the innovation on the underlying TriZetto product in continuing to improve and modernize that product?.
Sure, Lisa. We’re just thrilled about the technology and the capabilities, the subject matter expertise, the relationships we’re getting as part of the TriZetto acquisition.
We are planning – we want to make sure we continue to have best-in-class products and so certainly we’re going to invest in the TriZetto platform and equally importantly remember, we also now have a really world class platform that we – as part of the Health Net acquisition and we’re going to invest heavily in that.
So we’ll have a range of platforms that as we invest in them, we believe will be best-in-class depending on what the specific needs are of the clients. So we’re taking something that’s good and we plan to make it even better..
Perfect. And then I think when you first announced TriZetto, it looked like sort of from the charts on the revenue synergies that the majority of the synergies expected in 2015 were likely to be systems integration work related, which I guess interpret to mean Cognizant selling your services into a lot of TriZetto’s base.
Can you just talk about a bit of like tactically what’s the plan is there to kind of drive quick revenue synergies in 2015?.
Sure, so obviously we’re only in the planning phase, right now.
We haven’t begun any of the execution and we wouldn’t until the transaction closes, but certainly there’s synergy opportunities where clients are interested in broader range of services that Cognizant has the capability to offer at scale, where TriZetto on its own would not have had at scale.
So clearly that opportunity exists and those are near term. Longer term obviously, the big opportunity in our mind is the – having a fully integrated offering, similar to what we’re doing to Health Net where we do that with the TriZetto platform, but obviously that’s a much longer sale cycle.
So I think you’re right in thinking about the synergy on the IT services near term and longer term is the full stock opportunity..
Great. Thank you, guys..
Our next question comes from the line of Joseph Foresi with Janney Montgomery Scott. Please proceed with your question..
Hi, I think you talked about on maybe the last call $200 million of incremental revenue. I was wondering is that still a relevant number for 2015.
And how should we look about that – at that given the visibility on Health Net and the acquisition has probably improved as well?.
I think that the $200 million number is the right number, that’s certainly – that’s certainly what that we’re focused on. That reflects the timing of when we think that Health Net deal will close. So yes, I think our prior thoughts on that are still applicable..
Okay. And then just sort of a two-part question if I could, in some of the contracts that you had some issues with this year, has – what can we expect for those to – from a comeback perspective in 2015, do you think you’ll get half of that business back and some of it.
And then the second part of that is, did seasonality change at all, now that you’re doing a little bit more.
It sounds like transaction based work on the healthcare side?.
So let me start with seasonality. Certainly, in the platform business or the TriZetto business there is more seasonality than in our traditional business weighted towards the fourth quarter.
But given the overall size of the company, I don’t know if it significantly moves the needle on overall company revenue, but for that, that piece of the business certainly there's more seasonality.
Sorry could you repeat the first part of the question?.
Yes, I was just wondering some of the business got pushed delayed, or maybe even you lost it heading into the back half of this year cause you to change your guidance.
I was just wondering, what can we expect, is that going to be fully recovered in 2015, or will we get half of it back? I’m just trying to gauge sort of, how that works out into next year’s numbers?.
Sure. So I would not think about it as pent-up demand, where they just defer the project and therefore they’re going to give us that plus normal business. So I think that the revenue that we got hit with this year, that is – that revenue is lost now.
Will some of these accounts start to grow, and I think the answer is yes, some of them will – but certainly not all of them. But remember, put it in perspective, we are talking about a single handful of accounts..
Right, great..
So we’re very comfortable with where we are and with those accounts is playing out, just as we expected..
Thank you..
Our next question comes from the line of Keith Bachman with BMO Capital Markets. Please proceed with your question..
Hi, thank you. I had two, also, the first is, perhaps for you Karen. Could you talk a little bit about the puts and takes in operating margins for this quarter relative to last year? Your non-GAAP operating margins were down about 90 basis points.
And as part of that discussion for both, the September and December quarter, the variance between GAAP and non-GAAP has widened a bit, both from acquisition-related charges, as well as stock-based comp. Is that going to be a relatively static spread, as we look at the December quarter? And then I have a follow-up please..
Sure, Keith. So on the operating margin versus last year, two big things, one is obviously raises kicked in Q3 as we had expected them to. And then the second thing is utilization. So utilization with the 12,000 hires that we did in Q3 is up or is down rather quite considerably over two points from last year.
So it’s really that combination of utilization and then raises and promotions, which took margins down into the 19.5% range, frankly as we had expected we said the margins would come down from where they had been running in Q2 and generally right in line with what we expected. Then in terms of the GAAP to non-GAAP spread, that will fluctuation.
So obviously once we close the TriZetto acquisition, acquisition and amortization will increase quite significantly. We'll obviously have better color on that when we actually close the deal and can provide guidance on those numbers.
But what you did see in Q3 was some of the acquisition-related expenses due diligence and so forth, and that will obviously spill over into Q4 as well moving forward.
So, certainly over time, we would expect that debt to grow, which is one of the reasons, frankly, why we’ve been moving towards this non-GAAP definition and non-GAAP guidance moving forward..
And let me just add to that. We clearly think the way to think about the businesses on a non-GAAP basis, particularly as the spread widens due to the purchase accounting on TriZetto..
Okay. Related to that, Gordon, is my second question.
When you think about closing TriZetto and Health Net, could you just confirm how we should be thinking about that as we look at calendar year 2015? I know you don’t want to give us specifics, but philosophically, is there any reason why you would maintain in that 19% to 20% range, as you approach FY'15, including even the beginning of the year as you are trying to integrate these assets?.
Certainly, on a non-GAAP basis, I think, it is a very good assumption that we would stand on 19% to 20% non-GAAP operating margin range, including the impact of both Health Net and TriZetto..
Okay. Thanks very much, guys..
Our next question comes from the line of David Togut with Evercore. Please proceed with your question..
Thank you. Karen, could you provide a little bit more detail on wage and pricing trends you referenced the wage increase in Q3, and then earlier in the call you talked about stable pricing.
Can you just flash that out a little bit more?.
Sure. So let me start with pricing and then I think ask Gordon to cover up on the wages. So in terms of pricing, generally, it’s been stable, obviously you will have mix shift that happens so BPO is stronger than consulting, for example.
But I think, we’ve seen a very consistent trend over the last several quarters of stable pricing clients and much more focus now on the total cost of outsourcing and looking for partners that can provide real value and provide both the – as we talked about the run better and run different side of the equation.
So help them drive down their cost of doing business, but also help them drive innovation, and that balance is what frankly allows you to maintain stable pricing as long as you’re providing appropriate value. But I'll let, Gordon, talk about the wage increases..
So wages landed right in line with what we indicated last quarter, which was a bit above 2013, and I was expected and we talked about that last quarter. So offshore wages were right around the 10% mark, on-site wages were low-single digits, but about a point higher than it was last year.
So a little bit up from last year, but no surprises compared to what we thought three months ago..
Thanks.
And just could you quantify the revenue from Cadient?.
It’s about $4 million in Q4, there was none in Q3. That deal closed in October..
Thank you very much..
Our next question comes from the line of Sara Gubins with Bank of America Merrill Lynch. Please proceed with question..
Hi. Thank you. Good morning. Just a follow-up on the discussion about four to five large clients that pulled back.
Are some now indicating that the ramp growth backup in early 2015, and not pent-up demand, but just the normal course?.
Both four of those clients and all our clients in general, obviously we’re smack in the middle of the budget process this year. So it’s a little too early to know what each client’s going to do, some – I would expect some of those to have growth next year, that’s probably not all depending on where they are.
So it will be mixed bag and that’s – and that, and we’re very comfortable with that..
Okay, great. And then separately back on utilization, you’ve done a nice job of improving utilization over the last 12 months.
I know it’s impacted by turning around new hires, but as you look out to next year do you see that as an area where we could get continued margin leverage?.
I don’t think there will be a meaningful leverage off of utilization, clearly, we have opportunities in our pyramid. And so we’ll certainly look at that lever a bit. Three is a little of room offshore, on-site we are at our target utilization. But as, I think, Karen mentioned, we certainly have ramped up our hiring of college students.
We’re just getting the top, we’ll get such high quality college students right now because of the brand that we’re enjoying both and that’s college hiring in the U.S., in India, as well as Europe, across the globe. So I would think more about pyramid as the level for 2015 less so about utilization..
Great. Thank you..
Our next question comes from the line of Jason Kupferberg with Jefferies. Please proceed with your question..
Good morning, guys. So I know it's obviously preliminary to give any specific numbers for next year, but conceptually given the fact that demand condition seem to be fairly healthy, and you have Health Net as well as a couple other deals ramping up next year.
Is there any conceptual reason why organic growth can't be in a similar range next year as it is this year?.
Look I – what I'll say, we feel good about the demand environment, right now. We – the dual mandate that we talked about, it’s truly playing out across the industries we serve. We see a large number of, what we think of it multi-tower integrated deals in the pipeline.
I look at that as a proxy for one side of the dual mandate or the efficiency effect in the side of the dual mandate. And then as we’ve said many times, we feel very good about how we're positioned for the demand for new digital technologies. So, fundamentals of the demand are strong.
Having said, if you step back and you look at macro environment right at the big market, highly fragmented, lots of geographic growth opportunity for Cognizant, when we think about our presence in the Continental Europe and Asia, those are small, but – small market for us, large market opportunities.
So I think the fundamentals are strong, demand remains strong, and we’ve got a great client base. We were impacted this year by the small handful of very specific client situations.
Those we believe abate by the end of the year, so going into next year, we feel good about the environment, early conversations with clients don’t give us cause for concern at this point. .
And my next question about the demand environment, I mean, in terms of the integrated deals, which obviously are larger in terms of the (inaudible) presumably longer in terms of their sales cycle.
Is that something that we should think about being semi-permanent, at least, part of your pipeline? In other words could there be more lumpiness going forward?.
I think it’s fair to say, you will see more of these in the pipeline. But just keep it in perspective, this is still a small number or a small number of the overall – our pipeline of the overall opportunity that we have. The vast majority of our business still comes from the old land and expand that we've always talked to you about.
So, yes, would I expect to see some more Health Net life deals, certainly we talked about that in the context of the synergy opportunities we see from TriZetto, for example.
So I think those will be in the pipeline and the sales cycles there will be longer, but I think that the core base business will continue to be as we have historically been sort of the land and expand kind of work..
Okay. Thank you..
Our next question comes from the line of Brian Essex with Morgan Stanley. Please proceed with your question..
Good morning, and thank you for taking the questions. I just wanted to touch a little bit on your balance sheet philosophy.
As you introduced into the balance sheet and you closed on few acquisitions, what is the longer-term philosophy is maintaining on the balance sheet and, perhaps, also the mix of cash offshore, and what kind of flexibility you anticipate to maintain going forward?.
So, Brian, you touched on the key issue there. A good chunk of our cash is offshore, certainly we can use it for non-US acquisitions, but it is quite expensive to bring home.
When we look at our cash flow characteristics for the company, as excluding future large acquisitions, and as we said, we are not planning to do any future large acquisitions until TriZetto is well integrated. The – our cash flow characteristics in the U.S.
do enable us to do some – continue to do some share repurchases in the U.S., obviously we couldn’t do that in Q3, because we were blocked out. Longer-term, the key is, we want to make sure, we have the flexibility to take advantage of the quickly changing market, yes, we still have a lot of work to do in various geographies.
So we have not laid out a specific mix of how much the share repurchase versus dividends, versus acquisitions. We want to make sure that we continue to take as a – act as a leader in the market and stay ahead of our clients in terms of where they want to – what type of services they want.
But certainly, we do have both the authorization for additional share repurchases and we'll have the cash flow to resume doing some of those going forward..
Okay.
And then just to kind of touch a real quick on TriZetto, it looks relatively vertical specific, particularly with regard to the packaged software side of the business, and how do you think about translating that technology over to adjacent verticals or different verticals and leveraging them across other industry groups?.
Yes, it’s Frank, Brian. Look, I think, as you pointed out, the vast majority of TriZetto is very focused, very specific to the healthcare vertical. So I don’t see opportunities to take their technology to other verticals once we close the transaction. There are couple of exceptions to that.
One is that TriZetto have some very interesting advanced automation, software robotic kind of technology that we've acquired in the healthcare space, which we think could be relevant across the industries.
We think that advanced autonomics and robotics – software robotics are very important advanced automation technologies that will be very relevant to our business going forward, across the industries and in particular lines of business like our BPO, BPS service offerings, our IT infrastructure service offering.
So there are some pockets of TriZetto technology that we think will apply to other industries..
Okay. Thank you..
Our next question comes from the line of Glenn Greene with Oppenheimer. Please proceed with your question..
Thank you. Good morning.
I want to sort of touch on the 4Q guide, and the actual increase in the guide on the context of pretty meaningful FX headwinds, so it’s actually a pretty strong uptick in the guide, maybe, Gordon, if you could give us a little bit color around that and the thinking being was the client specific headwinds coming out of 2Q, is that somewhat less than you had thought, any potential for year-end budget flush, but just a little bit more color around the uptick in the 4Q guide, which is kind of unusual for you?.
Gordon Coburn:.
If I look at what's – what people are spending on, there is just tremendous interest in digital and SMAC services and people is trying to get their feet wet with that. So I would not think about it as the handful of clients flushed out sooner than we expected, those are playing out just as we expected.
But across the rest of the customer base, we are seeing a little bit stronger performance than we would have originally thought..
And no budge flush issues?.
We are not seeing anything, we are seeing some furloughs actually, not seeing any material budget flushes..
And then just finally on the head count hiring, which is pretty aggressive both year-over-year and Q-to-Q, is that somewhat of a catch-up from slower head count growth during the year, or how do we sort of think about that in the context of sort of heading into 2015?.
So little bit of a catch, obviously we are taking the utilization up quite a bit. The skills that we need to shift a little bit, so we wanted to make sure we don’t have any skills mismatch, or so we sacrificed a little bit of utilization just as we get that all aligned.
We also wanted to bring all of the college students on board by the end of this year who are graduated in May. We thought that was important, so about 45% of the hiring in Q3 was the college students.
So you put it altogether, it enables us to make sure that we are going to have the right skills for the change in demand and position ourselves well, so we don’t have revenue leakage as we go into next year..
Okay. Thank you..
Our next question comes from the line of Steven Milunovich with UBS. Please proceed with the questions..
Thank you.
Regarding the SMAC revenues, are you willing to update how much they are this year? And I guess, my question is that Accenture claims that about 17% of its revenue is in the SMAC category, you appear to be quite a bit less than that, why is that?.
So in terms of – so, Steve, in terms of the overall revenue, we have not provided an updated detail, we've talked last year about it being about $500 million, but it is as Gordon mentioned previously, it is certainly growing very fast right now, and certainly faster than company average.
I will let Frank actually add a little bit more color around what he sees in the marketplace..
To your second question, I think, part of the issue is that, so much of what we do now is across the business, is what I would broadly categorize as digital or digital related that it really depict, comes down to sort of a definition of what you are defining digital to be.
The – when we gave you the number, we did about a year ago, of about $500 million of SMAC, that was a relatively pure definition of technology, services related to social, mobile, analytics, and cloud. Digital has expanded well beyond that right now, and I would say it touches almost every aspect of Cognizant's business.
And so from a definitional standpoint, I think that, comparing across the industry to say, how much of revenues digital becomes somewhat tricky, because it really depends on making sure that you are looking at apples-to-apples and I'm not sure there is a good way to do that at this point.
Having said all of that, I feel very confident, the measure I use that I think is most relevant is, how we are doing in the marketplace and what are our win rates and how our customers telling us we are doing with respect to digital technologies, and I feel very good about that. Our win rates are solid.
The work we are doing for clients is transformational and digital, and we feel good about how we are positioned going into next year from a digital standpoint..
That’s helpful. I agree, it’s not clear, it’s apples-to-apples.
And then I want to ask about BPO or BPaaS, I hear investors having some concern about looking back historically how many will successful BPO platforms can you point to? What's the margin going to be on this business versus your historic business? It sounds great to generate your own IP and so forth, but what comfort can you give us regarding the profitability for the BPO business going forward?.
So when we look at what we mean by BPaaS, a combination of infrastructure platform, our people doing the processing clients behind the outcome, leveraging both the global delivery model and obviously very deep IT capabilities. Certainly, we have to make assumptions about productivity gains and so forth.
But as we have a lot of track record of understanding of what we can achieve in terms of productivity on these, so I actually feel quite comfortable with it. Now, obviously the timing of profitability differs on these deals.
The profitability tends to ramp up as you go through the transaction, but as long as you have enough of them in the system and stagger it out I think it should be fine. And the reality is, this is the way the market is shifting.
Clearly, this is what clients want to buy, so we have to make sure that we have a highly competitive offering and an offering where we make the margins that we want. And we’re very focused on that. We think it’s quite achievable..
Thank you..
Operator, we have time for one last question..
Thank you. Our final question comes from the line of Moshe Katri with Cowen and Company. Please proceed with your question..
Thanks for squeezing me in. Gordon, is there anything different that we should look at in terms of our assumptions for Health Net next year and specifically in focusing on the regulatory approval process? And I think you’ve indicated in the past, I thought that it happens.
I mean, we’re talking about four states, and we thought that this thing probably gets completed by the middle of next year.
Do you feel that this thing actually happens earlier than that or this is still middle of next year?.
I think your assumption is correct. Health Net has stated publically that they would expect to receive regulatory approvals in the first-half of next year. So I think the assumption that you’re making is probably an appropriate one..
So the contribution to the income statements starts following through in Q3 or sometime in Q2?.
It gets phased a little bit, because there’s some preliminary setup work and so forth, but the significant impact happens once we have regulatory approval and we go live..
I’m assuming starting in Q3 and then maybe getting a bit stronger in Q4 of next year..
Moshe, so the contract actually ramps over the first two to two-and-a-half years, so it will ramp up over time in 2015 and 2016 and in 2017..
Yes, we’ll give more color on how to model it as or we’ll give a little more color on seasonality when we talk about our guidance in February..
All right. Thank you..
Yes, thanks, Moshe. And thanks everybody for joining us today and for your questions. We look forward to speaking with you again, next quarter..
This concludes today’s Cognizant Technology Solution’s third quarter 2014 earnings conference call. You may now disconnect your lines..