Cognizant Technology Solutions Corp ($CTSH) Q4 2024 Earnings Call

Thank you, Ravi, and thank you all for joining us. Our fourth quarter results underscore the progress we have made against our strategic priorities to improve commercial momentum and enhance operational excellence. Fourth quarter revenue of $5.1 billion grew 6.7% year-over-year in constant currency at the high end of our guidance range. Organic revenue growth was driven by health sciences which grew more than 10% year-over-year and financial services which grew approximately 3%. Our acquisitions of Third Era and Belcan have supported our entry into new end markets with attractive long-term growth profiles. Fourth quarter revenue included approximately 450 basis points of year-over-year growth from these acquisitions. For the full year, revenue of $19.7 billion increased 1.9% year-over-year in constant currency and included approximately 200 basis points of growth from Third Era and Belcan.

We were very pleased with our fourth quarter adjusted operating margin of 15.7%. This performance driven by completion of our NextGen program and our rigorous actions to strengthen operations drove full year adjusted operating margin of 15.3%. This was 20 basis points ahead of our guidance. This also represents 20 basis points of margin expansion year-over-year net of significant investments we have made to accelerate growth such as Belcan and our AI platforms.

Now let's turn to the details of the quarter by segment. Health sciences saw broad-based strength across payer, provider and life sciences markets. Clients continue to prioritize cost optimization, cloud migration and legacy modernization projects which are helping to more than offset the muted discretionary spending environment. Within financial services, growth was balanced with positive trends across capital markets, cards and payments, fintech and commercial banking clients. We saw a further gradual pickup in discretionary spending in North America. We are seeing an improved pipeline of opportunities for transformation and modernization projects across both insurance and select areas of banking and financial services clients. In addition, we have continued to see healthy growth in Canada driven by recent new bookings.

Products and resources or PNR growth was driven by Belcan. As we noted last quarter, the segment has been pressured by cautious discretionary environment across end markets. This includes automotive, aerospace, manufacturing and logistics among others. We signed three large deals in this segment in the fourth quarter. Despite the near-term pressure, we are excited about the opportunities we see across PNR where the convergence of information technology and operational technology is rapidly accelerating. Communication, media and technology performance was consistent with last quarter as clients remain focused on cost optimization and discretionary spending budgets have been pressured. From a geographic perspective, growth was led by North America which increased more than 8% year-over-year. Health sciences, Belcan, and banking and financial services all supported the growth. Europe grew by about 1% year-over-year. By segment, strength in health sciences and financial services were offset by softness in products and resources. And finally, rest of the world increased about 4% year-over-year. This reflected solid growth across most segments.

Now, turning to bookings, fourth quarter bookings increased 11% year-over-year driven by large deals. On a trailing 12-month basis, bookings grew 3% year-over-year and represented a 1.4x book to bill. Trends in smaller deals improved, which supported a low to mid single-digit increase in our trailing 12-month annual contract value both sequentially and year-over-year.

Turning to expenses, Q4 marked the end of the NextGen program and we incurred about $49 million of costs related to the program in the quarter. Excluding the impact of these costs, adjusted operating margin was 15.7% significantly above our expectations. Year-over-year margin declined by 40 basis points, primarily reflecting the impact of Belcan and increased compensation costs. This was partially offset by savings from NextGen, high utilization and favorable currency exchange rates. We are pleased to be exiting the year with an improved cost base and more resilient operating model.

Now moving to cash flow and capital allocation. Fourth quarter free cash flow was $837 million. This brought full year free cash flow to $1.8 billion or 82% of our net income. This is in line with our guidance. As a reminder, free cash flow was negatively impacted by the previously disclosed impact from a $360 million payment made to Indian tax authorities in relation to our ongoing dispute of our 2016 tax matter. We ended the year with cash and short-term investments of $2.2 billion or net cash of $1.3 billion. DSO of 78 days decreased by 3 days from third quarter and increased by 1 day versus the prior year. For the full year, we returned $1.2 billion of capital to shareholders through share repurchases and dividends, including $300 million in the fourth quarter, and we invested $1.6 billion in two strategic acquisitions.

Turning to our forward outlook now. Before I start, I would like to reiterate that our strategy is built around driving long-term EPS growth through revenue growth and modest operating margin expansion which we believe will support enduring shareholder value creation. For the first quarter of 2025, we expect revenue to grow 5.6% to 7.1% year-over-year or 6.5% to 8% in constant currency. Sequentially, this represents a range of negative 0.5% to positive 1% growth on a constant currency basis. For the full year 2025, we expect revenue to increase 2.6% to 5.1% or 3.5% to 6% in constant currency. Details of revenue in dollars are available in our earnings release and supplement. We expect Belcan will contribute a little more than 250 basis points of growth in 2025 with a greater contribution in the first half of the year compared with the second half. As a reminder, we closed the acquisition of Belcan at the end of August 2024 and it contributed approximately $300 million to our 2024 revenue.

For the full year, we expect adjusted operating margins will be 15.5% to 15.7%. This represents 20 to 40 basis points of expansion of our strong performance in 2024. Over time, we expect our growing adoption of automation and AI to drive better productivity and higher margins. We remind you that in the first quarter, seasonality typically drives a modest sequential margin decline. We expect our full year adjusted tax rate to be between 24 and 25%. Some of you may have noticed that we are no longer providing net interest income guidance. We made this change to align our guidance metrics more closely with the industry. For the full year, we expect our net interest income will decline modestly given lower cash balances exiting the year. This leads to full year 2025 earnings per share guidance of $4.90 to $5.06. This represents 3 to 7% growth compared to our 2024 adjusted EPS. This growth includes more than 2 percentage points of expected headwind from unfavorable foreign currency exchange rates impacting reported revenue and other below the line items including slightly higher tax rate. For the full year, we expect free cash flow will represent more than 90% of net income. In 2025, we do not expect material changes to our capital allocation strategy. We plan to balance the return of capital to shareholders with inorganic growth investments that strengthen our capabilities and support our growth ambition. For the full year, we expect to return approximately $1.2 billion to shareholders including about $600 million in share repurchases and the remainder towards our regular quarterly dividends. We expect a weighted average dilutive share count of about 493 million for 2025 and during the year we plan to repay the $300 million outstanding under our credit facility. With that, we will open the call for your questions.

And it is a very good spread. So it is resilient and sustainable for the future.

Yeah. So because we have the breadth and the resilience now, our growth is going to be very broad-based and all round. You've seen healthcare we have done 10% year-on-year which is pretty healthy on a good big base. We are having pretty all round growth all the way from payer, provider to life sciences. On financial services where I started last year to where I am today, we have now created a rhythm of year-on-year growth for subsequent quarters and we are very excited about the fact that financial services we're seeing discretionary coming back and we are actually capturing a lot of that. Now we are starting with the muscle we have created on a broader capability, we are starting to see communications and technology which is a muscle we created in the last two years is doing well. Products and resources with retail and consumer goods was otherwise doing well and now we have strength in manufacturing with the power of the Belcan capability we built. So it's an all round comprehensive organic growth we're looking at. And I'm also excited about the fact that while Americas is actually a principal market and it is leading the way, the international markets are starting to contribute to this process. Our first quarter guidance is pretty strong. This is one of those quarters which is normally seasonally weak but if you see the midpoint of that guidance range we are positive. So it is tail velocity from quarter 4 cutting into quarter 1 plus all the momentum we have.

Yeah. So it's the start of the year. The visibility into the second half you kind of build it in the next few weeks. We are hoping there is continued buoyancy into the second half so that the upper end of the range is doable. So the way I constructed it is there is a trail velocity into the first half of the year and that is constructed to the middle of the guidance range and then we are hoping we continue to execute well we continue to see the same buoyancy we're seeing now. Discretionary is starting to come back and as the visibility builds in we do our best to outperform. If you look at the last four quarters, we got to the upper end of the guidance range in the last four quarters including the one we just concluded. So I would say that's how I'm seeing it. There is, when I spoke to all of you one quarter ago to where we are today, I'm more optimistic about the future.

Yeah. So I spoke in detail just a few minutes ago. Yes, I think I put this in three vectors. The first vector is writing code. I'm a strong believer that writing code with machines amplifying humans is only going to get us to write more. We will unlock billions of dollars of legacy technology debt sitting on corporate landscapes backlogs and we are seeing that in our deals now. One of the reasons why we're winning large deals is productivity is baked into it and the early investments we made is helping us to win because the productivity assumptions between providers is very different. We've done now 29 plus 17 deals in the last two years, a lot of that productivity we've baked in is AI. So we are excited about the efficiency part of this process. The second lever is how does it help on innovation and growth. Our clients are starting to invest on us. We have 1200 projects running now. And a lot of heavy lift cloud migration, data modernization, the last mile infrastructure, we have platforms to help our clients that helps us to create a stickiness and helps us to accelerate that journey and helps us to make that journey of agentification predictable. In fact we have our own agentification platform which is an orchestration layer. If you have existing software which has agents, this can orchestrate between the software pools. If you do not have an agentification layer, this can actually act as an identification layer. So we think we are way ahead of most of our peers and this is probably an opportunity of a lifetime. It is also unlocking new pools of addressable spend which we didn't earlier address which is things I spoke about like connected care or retail operations or drug discovery. So the service pools which we didn't capture before are now available to us. So we are now seeing opportunities which are not just at the CIO, it's actually across the business operations of a company. So I think the addressable pool of work is going to be multifold to where we were before and that gives me confidence that this is a force multiplier for companies like ours. In context to DeepSeek, it's a simple quick summary: DeepSeek has uniquely democratized a layer at the back end which is the foundation models and it has commoditized that layer. So a lot of that money will now flow into the front end and it will accelerate the adoption of AI into enterprise landscapes. And as it does so, we will be in the middle of it heavy lifting and helping our clients. So the DeepSeek opportunity uniquely is an inflection point on transferring that value from the back end to the front end.

Thank you Surender. If you remember in the London conference I started talking about this and we've come a long way from there. The layer of software you build I call fast software is practical tooling needed by our clients to either accelerate the journey or to bridge a gap or potentially to build microindustry vertical templates which the existing software doesn't contain. Very similar to how enterprise software was built many years ago. How the cloudification of technology in some ways changed the role of system integrators. Now I would say all of this is helping our clients. I'll give you one example. We have a platform called Flow Source which is an orchestration layer on top of code assist platforms like GitHub. Now that orchestration layer is something we built practically because we figured out that as you bring code written by machines and you bring code written by humans and you bring it together you need a developer workbench which will synchronize that effort and improve productivity. And will some of the existing platforms replicate that functionality over a period of time? Maybe yes, but by then we will start to look at advanced problems to solve. Some of those problems we have today, some of the gaps we have today will remain gaps and it's the job of a system integrator to fix them and some of them will productize and as they get productized we move to the next endeavor, the next problem solving endeavor. There is work between efficiency of the output and cost efficiencies needed for making AI enterprise grade. Some of that optimization will automatically happen with software and some of it will not. So I would say it's an evolving role of a system integrator. The heavy lift will remain. I am now venturing not just into agentifying landscapes. I'm venturing one step further which is identifying new service pools which we did not capture. I'll give you one example. If you take sales and marketing function, all the data sitting in software is structured data. If I actually tap into unstructured data in a sales cycle, there is data sitting in chat messages, data sitting in emails, data sitting in minutes of meetings of sales people who are actually working on and if you want to find the momentum of a company's sales momentum you could identify that pool and then transfer that into value which means that was a labor pool we didn't touch either. People were doing it and we didn't capture it or new sets of work which people were not doing which is unstructured data it was not getting tapped. So I see this as an opportunity for not just technology spend of enterprises, I see this as an opportunity to go into the operations of companies and agentify it and create service pools which we can address. And we do believe our strength at that intersection of deep engineering operations and industry domain will help us. And this is no longer theoretical. This is real life projects we are now implementing for our clients. And some of those examples I've already stated in my remarks.

Yeah. So I'll take that. I think the texture of the work is changing a little bit between 24 and 25. In 24 we saw that it was essentially the large deals and the volumes led by large deals were driving the growth. But 25 as we exit particularly quarter 4, we have seen some improvement as I described in my opening comments in annual contract value terms which means we are getting some discretionary spend back and therefore the volume or the texture of growth will be slightly different for 25 where you will see both the short end work as well as the volumes which are being added by the large contracts or large deals. Especially in financial services where there is more discretionary. In fact, Surender, I just mentioned earlier that our ACV numbers have significantly jumped in quarter 4, which is an indication of not just large deals but also smaller deals coming back.

Sure. So while you are seeing numerically the utilization looks softer in quarter 4, we continue to execute very well on the ground. So this under represents the operational improvement that we have been able to achieve over the last 12 months in the way we run the organization. So I think that is one big driver that is also reflected in the performance on the gross margin side. We have definitely seen a benefit on the profitability coming through our NextGen program. That is another key contributor to the performance for 2024 in general and specifically for quarter 4. So overall our operational rigor has improved significantly in the last two years and we have some runway. We have the pyramid, we're continuing to sharpen the pyramid, AI productivity sharing with our clients and share part of it accruing to us. NextGen program which we started in 23 flowed into it. It had a flow through into 24 and it will have a flow through into 25. So we are very excited about it and the large deals for which we were always budgeting if something goes wrong but the reality is the bid versus date on large deals also contributed to the margin growth. We have really executed our large deals very well. So we are very pleased with where we have landed on the margin and the runway we have for 25. And interestingly we've also done M&A and we have absorbed the margin dilution plus we are investing heavily into AI, we are absorbing that as well. So the ability to contribute to margins, create an expansion, and that's going to be my desire. We're going to keep an expansive desire to improve our margins, but continue our investments and stay ahead of our peers.

So we continue to hire as we need for our growth and certainly it's a cycle that you will see panning out in 2025 also. Probably from Q1 and onwards you should start seeing the addition of headcount versus what you have seen in previous few quarters. Overall we are well placed in every geography from availability of talent from a bench standpoint as well as our capacity to hire as we need in each of the geographies. So we feel quite good as we enter 2025 from a supply equation standpoint.

Yeah, sure. So essentially this provides for the 250 basis points is the number that I have mentioned in my opening comments and that 250 basis points is essentially for the additional 8 months approximately 8 months of revenue that we will get from Belcan in 2025. We have not factored in any additional inorganic in that 250 basis points.

Yeah. So I mean this is sectoral in a way. But I also want to tell you that the mood is very business favoring right now. People are expecting regulation to be coming down and it's a pro business environment. The uncertainty around us is starting to settle down. There is lesser uncertainty in general across the world. Which means all those dollars will actually trickle down to innovation and discretionary work. I would say financial services, I'm very pleased with where we are at financial services which is where all the discretionary conversations are. We're very pleased with the progress we made and how we are seizing the opportunities which are coming our way. You would have noticed one other area I spoke about which is global capability centers. A lot of our clients are actually saying can you help us set up global capability centers which is interestingly one of our biggest trends. Setting up an AI shop for one of our clients but doing it in a build operate transfer. So a lot of all round opportunities to play with as the AI wave is hitting enterprises. The reality check on their data and their cloud migration is reopening that journey. The heavy lift on data modernization and cloud migration is a unique opportunity for us. We are a very different company now in two years. I would say we have a heterogeneity in our landscape on services all the way from experience, application services, BPO ops, to engineering and we now have more vertical play. We aren't just a financial services healthcare company. We now have multiple verticals to play with. So I would say I'm optimistic. I don't know if things will change in the second half but I'm optimistic about the fact that where we were a year ago or where we were a quarter ago to where we are now, I feel very optimistic.

So multiple things for Cognizant to be a part of that chain. One third of the work, one third of the tech services in offshoring destinations like India is GCCs, so we have a big role to play. They are themselves directly buyers of services, so that's fun. Second, a number of them who do not have access to that market because that's a different labor market. We are a sizable formidable player in India. So it gives us an opportunity to help these companies build, operate and transfer. In fact, last year I signed a deal. It's in the public domain. Where I did build, operate, transform and transfer. Essentially, we are building it for them. We're operating it with them. We are applying AI tooling and then we are transferring it to them and then we underwrote all the AI tooling for the next couple of years. Which means we are just going to give them they can draw from us. There is a third set of offering which is the microservices around a GCC which is you focus on the core and offload the non-core to us and we will set up for you. There are a variety of templates on this and companies are reorganizing I call them 2.0 and they're reorganizing their technology ops and BPO together. My universe is not technology anymore. Operations of companies are actually getting offloaded to nearshoring and offshoring destinations and that's a new addressable spend. And finally engineering of companies. If you are a car company you would probably outsource your HR applications and CRM applications, writing software to drive to run the car you're probably not going to outsource. You're going to build it yourself. Building it is not easy. So we can actually give you deep engineering capacity to build your own core. So we have a number of opportunities which we have won and which we have in the pipe and I've actually mentioned about one in my earnings which is primarily an insurer who just signed up with us. So we are kind of excited about this opportunity.

Yeah, technology is a very interesting space. When everybody is growing, you use technology to grow and if there is uncertainty, you use technology to improve efficiency. So you can win in the turns with technology. So I've seen it on both sides and I think as a company we are agile to anchor on both sides. When the market is soft, you want to anchor on efficiency. When the market is taking off, you want to anchor on innovation and I think in some ways AI can do both. So I'm anchoring on both sides and that's why I place this opportunity in those three vectors. Because I do see this as a play on both sides which is why it is exciting. Budgets are, the visibility of budgets are much better than last year. Is it completely up and running? I don't think so. As we move into the year we will see more. But we're in a much better spot than last year.

Thank you.

Is this specific to Europe or otherwise?

Yeah. So continental Europe still has uniquely first-time outsourcing opportunities which can manifest itself into not just offshoring but outsourcing and offshoring and sometimes in fact continental Europe has one of the most number of GCCs going back to the old topic. So I see that opportunity in some ways very different, it's in a very different stage of evolution in comparison to the US and UK. And some industries are very mature and some industries are really opening it up for the first time. UK is a much more mature market. We have a big role in UK. We are strong in financial services. We also do public sector in the UK. We are pretty strong in consumer and comps. So UK is a very different market. I think it's much more ahead in terms of outsourcing, offshoring and actually efficiency cycles. But I would say in continental Europe if we make the right investments which we are doing over the last 2 years, we are unlocking much more than before. Our presence is much, the proportion of business we do out of Europe and Asia Pacific is much lower than the US in comparison to peers, so that's an area for us to capture more and be a challenger in some of these geographies.