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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Greetings and welcome to the Cognizant Fourth Quarter 2017 Earnings Conference Call. At this time all participants are in a listen-only mode. The question-and-answer session will follow the formal presentation. [Operator Instructions].
It is now my pleasure to introduce your host, David Nelson, Vice President of Investor Relations and Treasurer. Please go ahead, sir.
Thank you, operator, and good morning, everyone. By now, you should have received a copy of the earnings release for the company's fourth quarter and full year’s 2017 results. If you have not, a copy is available on our website, cognizant.com. Additionally, we have loaded an investor presentation onto our website. This presentation covers the key points discussed on this call.
The speakers we have on today's call are Francisco D'Souza, Chief Executive Officer; Raj Mehta, 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.
Good morning, everyone and thanks for joining our call. This morning I’d like to cover three topics; first, Cognizant’s current view of the industry and where our clients are headed; second, a few highlights from our 2017 performance, which includes full year revenue growth of nearly 10%; and third, how coming off a solid year, we plan to use our momentum to deliver a strong 2018.
Let’s begin with how we see the current environment. In recent years the big story in tech has been the rapid rise of digital native players like Facebook, Amazon, Netflix and Google. Today another important story is being written with entirely new players. Companies that have long stood as the pillars of our economy are emerging as a new generation of digital heavy weights.
These firms many of which are longstanding Cognizant clients, are already leaders in financial services, insurance, healthcare, manufacturing and other industries. With Cognizant as their partner, they are combining their industry expertise and assets built over decades with powerful technologies like artificial intelligence, the Internet of Things, analytics, robotic process automation, cybersecurity and hybrid cloud to create entirely new performance thresholds and customer experiences.
This blending of industrial with digital promises to dramatically improve the way the world’s industries serve our needs and improve our lives. Digital technologies have become so integral to remaking business models and core processes that no enterprise can ignore them and still remain competitive. That’s why the rate of digitization across industries and countries continues to rise, and why digital now accounts for a substantial and growing percentage of new enterprise IT spending.
Most clients realize that competition today is not about being either digital or physical, but rather about being both digital and physical. Hybrid business models are the new way work will get done at the enterprise level.
As we continue our productive partnerships with our digital native clients, we’re also focused on building a strong position in the digital industrial economy. We are resolved to be the go-to-partner for this new generation of digital heavyweights, helping them figure out what stays physical, what goes digital and what becomes a mix of both.
Cognizant is only one of a handful of companies with a range of capabilities to help clients transform at every level of their enterprises. So we believe we are in a strong position to pursue this huge market opportunity for digital at scale transformation.
Now let’s review Cognizant’s 2017 performance. Throughout 2017, we stayed focused on executing our plan first articulated a year ago to accelerate our shift to digital services and solutions. As a reminder, the three elements of our plan are; to scale our three practice areas, maintain a robust core business, and fully implement our margin improvement and capital return programs.
During 2017, we made significant progress across all three elements. Here are a few highlights; first, we delivered four consecutive quarters of consistently solid performance at the top and bottom lines. Our 2017 revenue grew nearly 10% to $14.81 billion which was within our guided range for the full year. Second, we took a number of actions to improve our cost structure and slightly exceeded our full year non-GAAP operating margin target. Third, our 2017 digital related revenues grew almost 30%, well above company average and accounted for about 27% of total annual revenue. In addition in 2017, our portfolio of digital services generated above company average margins.
During the year, we also initiated Cognizant’s first quarterly cash dividend, returned $1.5 billion to shareholders through an accelerated share repurchase program, and launched the second phase of our share repurchase program, underscoring our confidence in the long term growth of our business. Overall, we believe our 2017 performance demonstrates the consistency of our execution.
Let’s now turn to the third part of my discussion, how our forward momentum will deliver a strong 2018. Beginning with guidance, we expect Q1 revenue to be within a range of $3.88 billion and $3.92 billion. And for 2018, we expect revenue to be within a range of $16 billion and $16.3 billion or growth of 8% to 10%.
We are confident in our ability to deliver a 21% non-GAAP operating margin in 2018. We remain on track to achieve our 22% non-GAAP operating margin target in 2019, while continuing to invest strongly in our business for growth and differentiation. And reflecting our confidence in our momentum and the benefits of the new US tax legislation, I am pleased to announce that our Board of Directors has approved a 33% increase in our quarterly cash dividend to $0.20 per share.
Propelling us forward is the comprehensive building, investing and operational strengthening of our business that we accomplished last year, all of which we will continue in 2018. Our three practice areas, Cognizant digital business, Cognizant digital operations, and Cognizant digital systems and technology are proving very effective at anticipating our clients’ needs and providing the most effective services and solutions for the parts of their enterprise they need to transform.
We continue to invest to broaden and deepen our services and capabilities and have intensified our focus on developing more end-to-end, industry-specific solutions. At the same time, we’ve expanded our geographic footprint adding new delivery and operation centers as well as collaborators [ph] in our key global markets. And through last year’s five acquisitions, we welcome to Cognizant talented professionals who are highly skilled in management consulting, digital strategy and marketing, user experience, industry focused platforms, and content creation.
When you put it altogether, the Cognizant difference is our penetrating knowledge of our clients’ business and technology environments and the problems they must solve, coupled with our ability to use technology to transform their entire enterprise. Think about what goes into this; Cognizant is able to engage with clients on their strategy, on their approach to customer interaction, on their product and service portfolio, on their financial and people models, their underlying business processes, operations, user interfaces, applications data and infrastructure.
We have the end-to-end capability, the domain knowledge, the global and local delivery, ahead of the curve investments, and non-negotiable client information to be entrusted with such a critical undertaking and to deliver from strategy all the way through expected results. There are simply no shortcuts to building all of this capability and making it work for clients.
Let me wrap up by returning to the subject I’ve spoken about in the past calls. As you may know, Cognizant’s enduring belief is that we must enable a broader range of people to have the stem education and skills they need to thrive in this new digital era. This belief is consistent with Cognizant’s ambition to be central to the digital economy and to contribute significantly to the communities in which we operate.
And so today, we are thrilled to announce the formation of the Cognizant US Foundation, a non-profit focused on providing stem and digital education and skills training for US workers and students. We’re establishing the new foundation with an initial grant of $100 million, which is supported by recent changes in the US tax laws. The foundation will focus on education programs in multiple cities and states across the US to help improve opportunities for US workers and their families.
As you may know in today’s rapidly expanding digital economy, there are far more open jobs for technical work than there are trained workers to fill them. In fact, the US Bureau of Labor Statistics projects a 1.4 million person gap in 2020 between software development jobs and qualified applicants. This skills gap threatens the competitiveness of American businesses.
To help close this gap, the Cognizant US Foundation will fund and develop stem education programs, public private partnerships, and other initiatives designed for high school graduates, community college and college students, veterans and others in the workforce seeking specialized technical skills for digital business jobs. As part of Cognizant’s overall social responsibility focus, we’ve been enabling stem education for a dozen years. The work of our new foundation will build on our global commitment to train tomorrow’s technology professionals, reskill and upskill today’s workers, and give back to the local communities where the company does business.
Our company runs on highly skilled talent. We are one of the largest employers of technology workers in the US. Last year we added more than 6,000 US citizen and permanent residents to our workforce. And over the next five years, we plan to hire at least 25,000 US workers. To support our growth, we have recruiting, training, and reskilling efforts underway in several American cities with plans to extend our training programs to other cities in the near future.
As the economy becomes ever more technology intensive, the need for workers to be career long learners is going to increase substantially in the years ahead, and Cognizant is determined to be at the forefront of enabling this.
Okay, now let’s turn it over to Raj, who will discuss how we’re working with clients to speed them along their digital transformation journeys as well as the specifics of our business segment performance. Raj?
Thank you, Frank. When you ask our clients what sets Cognizant apart, they’ll say it is our ability to create solutions that transform how they engage with their customers, run their operations, and modernize and secure their IT backbone. This year, to drive increasing value to clients and further strengthen our foundation for profitable growth, we continue to develop and deploy our broader portfolio of industry platforms and solutions across our three practice areas.
Examples include Cognizant MedVantage for the life sciences industry, Cognizant LifeAdmin Core for insurance, and Cognizant ClaimSphere Clinical Plus for healthcare to name a few. We also offer digital capabilities that cut across industries such as cloud enablement, legacy transformation, intelligent process automation, and more. Each of our practice areas has clearly defined its range of solutions and capabilities, and the distinct value they provide.
This has made it easier for clients to understand the full range of our capabilities. Given the increasing complexity and scale of the processes and systems within our largest clients, we’ve continued to evolve our client engagement. We’ve been embedding chief marketing officers and chief digital officers in each of the industries and key geographies that we serve. These leaders are supporting our aggressive drive to continue expanding our presence well beyond the CIO to other decision makers within our accounts.
In addition, we’ve continued to evolve our account leadership team, which are focusing on more output and outcome based results. They are helping clients optimize their legacy environment and fully leverage Cognizant’s increasing localization and integrated delivery. Last year, we skilled over 100,000 associates in high-end digital capabilities in areas such as data science, design thinking, cybersecurity, Internet of Things, artificial intelligence, and automation, and this year we’ll continue our substantial investment in training our associates.
At the end of the day, of course what matters to clients are outcomes. So let me offer an example of digital transformation work we’re doing for one of the world’s largest healthcare companies. In the medical device segment, where this client operates, market leaders realized that the quality of their field service and their ability to comply with regulatory changes are differentiators.
Working with a client, we can see the future of predictive services of seamless parts, management across the digital supply chain, and building quality compliance. We prototyped a future state for the client using Cognizant’s MedVantage, our integrated sales, service, complaint handling, and quality management cloud solution. We are now rolling out our solutions to more than a dozen of the client’s operating companies spread across 50 countries to meet the need of thousands of users.
Once our deployment is complete, we believe that client will be able to achieve significant benefits that include a 5% to 10% increase in revenue from service contracts, a 30% increase in the productivity of field service personnel, and a significant reduction in regulatory citation. This case study conveys the tangible value we can create for our clients, value in the form of increasing revenue, lower cost, and reduced error rate.
Now let’s turn to the financial performance of our industry segments and geographies in the fourth quarter. Banking and financial services grew 5.4% year-over-year. In the quarter, we had double-digit growth in our insurance business and in our mid-tier banking clients. In insurance, the growth was driven primarily by large strategic deals.
We see growing interest among the insurers, and they are using advanced technology. Examples include watching for secure data, sharing, drones for property inspection, and artificial intelligence to help decide personal injury claims.
Moving to banking, while certain large banking clients’ spending has continued to be under pressure, we see the beginning of a recovery as these clients sharpen their focus on an investment in digital technologies. We are prepared for this transition by all the work we’re doing to help them optimize their spending on their legacy systems and operations, and then apply these savings to driving digital transformation across the enterprise.
Turning to healthcare, our revenue was up 11.9% year-over-year. We saw consistent demand across payer clients and increasing interest in our digital, analytics, cloud and virtualization solutions. Healthcare delivery is shifting from fee-for-service to a value-based care model that is focused on effective consumer engagement with data driven insights.
As a result, healthcare organizations seek new ways to deliver consumer centric care while driving operational efficiency. This is leading to increased collaboration and partnerships across peers and providers. Our differentiated offering, which combines software and services position us to capitalize on these fundamental changes within the healthcare industry. The addition of TMG Health extends our position as a leading software-as-a-service healthcare partner in a growing market for government programs.
We now provide products and services to more than 430 organizations that support more than 70% of the Medicare Advantage and managed Medicaid markets. Within life sciences, we had a strong fourth quarter particularly in biopharma. Among our life sciences clients, we see growing interest in digitizing core business processes like clinical development and regulatory operations, as well as in transforming the patient and care experience.
Turning to products and resources, we increased revenue 13.7% year-over-year. We continue to see strong growth from our manufacturing and logistics clients, which offsets sluggish growth in retail. Our strength in manufacturing, logistics, energy, and utility areas result from our emphasis on leading the digital offerings. CXOs increasingly engage Cognizant to create smart products and transform their business models.
Communications, media, and technology had another strong quarter of broad based growth, up 19% year-over-year. In Q4, we had solid growth across all the sectors, with expansion in areas like creating and curating digital content. As you know, the digital economy is all about content and context, the right content to the right person at the right time through the right channels to create meaningful experiences.
And in Silicon Valley, our clients are relying on us to help support their operations not only in the US, but also globally, where they tend to have smaller operational footprints. Looking at our geographies, our international markets crossed the 3 billion revenue mark in 2017, reflecting our successful growth campaign. We’ve made good progress in integrating several recent acquisitions including Netcentric, Zone, Adaptra and Brilliant Service.
We now operate in 38 countries and much of our growth has been enabled by successful localization across our 37 centers, in which more than 30 languages are spoken. Europe grew 18.1% year-over-year in Q4, including a 640 basis point positive impact from currency and the rest of the world went up 17.5% from a year ago, including a 200 basis point positive impact from currency.
As a sign of our growing European reputation for delivering digital interactive solutions to C-suite decision makers, the Football Association which is based in the UK selected Cognizant as their digital transformation partner. We will be developing and managing digital solutions to make it easier for soccer’s 800 million global fans to build a deeper relationship with the sport and drive its growth.
To sum up, over the past year, we’ve focused considerable energy and investment in strengthening our foundation of profitable growth and extending our capabilities to help clients succeed in their transformational journeys. Karen over to you.
Thank you Raj and good morning everyone. Q4 performance was solid, rounding out our full year result which were within our expectations and reflect successful execution of our strategy to drive sustainable revenue and earnings growth. Fourth quarter revenue of 3.83 billion was within our guidance range and increased 10.6% year-over-year, including a 120 basis point positive impact from currency.
Non-GAAP operating margin, which excludes stock based compensation expense, acquisition related expenses and realignment charges was 19.7% and non-GAAP EPS was $1.03. In the fourth quarter, our non-GAAP tax rate was 22.4% and excluded the $617 million one-time impact of the recently enacted US Tax Reform Act, resulting primarily from the deemed repatriation tax on undistributed earnings on foreign subsidiaries.
For the full year 2017, revenue of 14.81 billion represented growth of 9.8% year-over-year, including a 10 basis points negative impact from currency. Non-GAAP operating margin was 19.7%, slightly above our guidance of 19.6% and non-GAAP EPS was $3.77. As part of the capital return program laid out one year ago, we repurchased $1.5 billion of shares in 2017 and initiated a quarterly cash dividend of $0.15 per share beginning in Q2.
In the fourth quarter, we launched the $1.2 billion phase of our capital return program through a $300 million ASR. We are currently evaluating the new US tax legislation and in particular the longer term impact that this legislation may have on our overall capital return program.
We are supportive of this legislation as it levels the global playing field and increases the competitiveness of US companies. The implementation of a modified territorial tax system will permit capital to flow across markets with greater ease allowing more flexibility for future investments.
As a first step, we are pleased to report that our Board has approved a significant increase of our quarterly dividend to $0.20, reflecting our confidence in the strength of the business, coupled with the benefits of tax reforms. This increase will bring our dividend more in line with technology peers, while allowing us to continue to invest strongly in the business both organically and inorganically.
Additionally as Franc described, we plan to significantly expand our ongoing commitment to stem education through our planned $100 million contribution to the Cognizant US Foundation.
Now let me discuss additional details of our financial performance. Consulting and technology services represented 57.3% of revenue and the outsourcing services 42.7% of revenue for the quarter. Consulting and technology services grew 10.2% year-over-year, driven by continued strong demand for digital solutions. Outsourcing services revenue grew 11.1% from Q4 a year ago, as we continue to see strong growth in digital operations and infrastructure services.
Turning to fourth quarter, 39.5% of our revenue came from fixed price contracts. We continue to make progress towards shifting the mix of our business over the longer term towards more fixed price or managed services arrangements. We added seven strategic customers in the quarter, defined as those with the potential to generate at least 5 million to 15 million or more in annual revenue. This brings our total number of strategic clients to 357.
And now moving to an update on margins in Q4 we continue to take actions that we expect will improve our cost structure and operating margins, while allowing us to continue to invest in the business for growth. These actions resulting in approximately $3 million of charges in the quarter, related to the realignment program. Going forward we may incur additional costs related to advisory fees, severance and further optimization of our real estate cost.
Additionally, as we accelerate our pursuit of broad based, high value digital transformation work, we will continue to reassess less profitable opportunities that do not further our position in the digital market place.
In 2018, we expect to make further progress to our target of 22% non-GAAP operating margin in 2019 through continued focus on driving higher value services in addition to continual improvement in our business, focusing on leverage such as sustained higher levels of utilization, optimal pyramid structure, simplification of our business unit overhead structure and leveraging our corporate function spend more effectively.
We have also invested in further automation of our systems and processes in key areas such as customer management and forecasting of supply and demand. We enter 2018 on solid footing after the steps we took in 2017 to right size our cost structure. The implementation of these savings initiatives allows us to continue to invest in our digital capabilities, while still delivering improved margins in 2018 and 2019.
Moving to headcount, another key metrics, offshore utilization in Q4 moved higher as we continue to effect structural changes in our headcount management. We expect that these changes will help improve our resource alignment, help drive greater operational efficiency and best improve our profitability.
We added 3900 net new hires in the quarter, while annualized attrition of 17.9% during the quarter including BPO and trainees decreased over 400 basis points from the previous quarter. Our offshore utilization for the quarter was 80%, offshore utilization excluding recent college graduate doing our training program was 83%, and onsite utilization was 92%.
Turning to our balance sheet, which remains very healthy, we finished the quarter with $5.1 billion of cash and short term investments. We had strong operating cash flow in the quarter, generating $836 million, reflecting improved profitability of the business. Receivable were 2.9 billion at the end of the quarter, and we finished the quarter with a DSO including unbilled receivables of 71 days down one day from the year ago period.
Our unbilled receivables balance was 357 million, broadly flat from the end of Q3. We’ve build approximately 63% of the Q4 unbilled balance in January. Our outstanding debt balance was 873 million at the end of the quarter, which included a $75 million outstanding balance on our revolver. Our diluted share count was 589 million shares for the current quarter.
I would now like to comment on our outlook for Q1 and the full year 2018. For the full year 2018, we expect revenue to be in the range of $16 billion to $16.3 billion, which represents growth of 8% to 10%. Our guidance is based on the current exchange rates at the time of which we are providing the guidance and does not forecast for potential currency fluctuations over the course of the year.
We expect the adoption of the new revenue recognition standard ASC 606 will be immaterial to evolve revenues. For the first quarter of 2018, we expect to deliver revenue at the range of 3.88 billion to 3.92 billion. For the first quarter, we expect to deliver non-GAAP EPS of at least $1.04. This guidance anticipates the share count of approximately 589 million shares and a tax rate of approximately 24%.
For the full year 2018, we expect non-GAAP operating margins to be approximately 21%, and to deliver non-GAAP EPS of at least $4.53. This guidance anticipates the full year share count of approximately 585 million shares and a tax rate of approximately 24%. This guidance includes the impact of the $1.02 billion share repurchase, which we anticipate will be phased in over the balance of 2018.
Our non-GAAP EPS guidance excludes stock based compensation, acquisition related expenses and amortization, realignment charges, net non-operating foreign currency exchange gains and losses and the additional impact of the enactment of the US tax reform act and our planned contribution to the new Cognizant US Foundation. Our guidance also does not account for the impact from shifts in the regulatory environment in areas such as immigration or tax.
Before I close, I would like to comment briefly on our longer term tax rate. As you know, our tax rate is determined by a combination of factors globally, including our geographic mix of earnings and related income tax rates and the jurisdictions in which we operate recent changes to tax legislation such as the US Tax Reform Act, and tax structures in various international markets. Based on what we know today, we anticipate that our tax rate will be in the 24% to 26% range beginning in 2019.
In summary, our solid execution in 2017, along with continued investment in the business has positioned us well to deliver another strong year of revenue and earnings growth in 2018.
Operator, we can open the calls for questions.
[Operator Instructions] our first question is from Bryan Keane from Deutsche Bank. Please proceed with your question.
Just wanted to ask about the large banking showing signs of improvement. Do you think that’s just a little bit of the tax reform coming through to spending, just trying to think about what could cause a little bit of pickup in that large banking side?
Bryan, this is Raj. Look, I think within banking, we’ve always had with our mid-tier banking accounts the demand environment and it’s been quite healthy, where the challenges has been on some of the large money center banks. And given obviously, we are starting to see a pickup obviously some with the tax reform, but some of the regulation changes, and you’re starting to see a lot of investments that are starting to come in in the forms of digital transformation.
And I think we’re positioned very well for those to capture that growth, but obviously we continue to balance along with additional engagements in digital. There’s still a focus on some of the optimization around the legacy work and we’re making prudent decisions in terms of balancing both revenue and margins on outlook.
And just one follow-up for Karen, just the first quarter ’18 revenue guidance, this is a little stronger than we anticipated. Anything to think about that is pushing those numbers higher, is that just a little stronger demand, extra days, just thinking about the seasonality there versus demand.
On a year-over-year basis Bryan, there’s a little bit of currency impact that’s helping with the growth as well as sequentially. But honestly, we think the year’s off to a solid start, so we think Q1 will play out quite nicely.
Our next question today is coming from Darrin Peller from Barclays. Your line is now live.
I just want to start off first with the embedded expectations for, I guess currency and M&A in the outlook, and then really more on the margin side, if you could help us just bridge a bit – a little more detail bridging the gap to the 21% operating margin expectation for the year from where you are now. I know it’s been a – it’s part of the plan over the few years, but maybe some more specifics on the gross margin and then some of the variables.
Sure Darrin, it’s Karen, let me take that. So let’s start with revenue guidance. So in the 8% to 10% revenue guidance, there’s about 100 basis points of currency right now that we see as the benefit year-over-year, so 7% to 9% on a constant currency basis would be the growth projection. There’s no incremental M&A built into that, so just obviously the full year impact of the deals that we did last year, so Netcentric and Zone, which we did in Q4 and then obviously the TNG contract you’ll get the full year impact versus this year, we’d about five months of that. So that obviously helps with the growth rate, but beyond that there’s no large deals or no M&A built in to the guidance at this point.
And then on the margin front, obviously we’ve guided to approximately 21% non-GAAP operating margin. A lot of that is driven by the benefit of the cost savings we’ve implemented in 2017 that will carry over into 2018. We’re also, as we’ve talked about, we’re seeing, as the business shift to more of the digital work that has higher value; it’s been higher margin work. So as we’re seeing that start to continue to become a bigger piece of the overall pie that will continue to drive margin expansion as well. And then we’ll continue to focus on continuing leverage around pyramid, will sustain high levels of utilization. We believe there’s more work to do in terms of scaling the corporate functions and really driving the leverage out of that. So it’s no individual lever, but there’s a number of pieces that will come together to drive the expansion.
Our next question is coming from Brian Essex from Morgan Stanley. You line is now live.
Karen I had a question for you on the taxes. Is there anything operationally that you’re changing, I mean tax rate in longer term coming in under, I think where we expected? Are you changing billing policies, transfer pricing, and might this potentially fix longer term issues of where you’re generating cash and where that cash gets trapped geographically?
Brian there’s nothing certainly that we’re doing in regards to the outcome of the US Tax Reform Act, obviously overall that is helping to drive the rate down. As you know in India over time the rate will increase as tax holidays start to expire and so that’s why in the guidance we’ve put a rate of 24% to 26% to accommodate a little bit of that increase as we look out into the future. But today, the rate has been and will continue to be based on a number of items including all the various geographies in which we operate, and nothing unusual that we’re doing though because of that.
Our next question is coming from Tien-Tsin Huang from JP Morgan. Please proceed with your question.
Just wanted to double check on the margin outlook, just any guidance on how we might see margins progress throughout the year and how it might be different than past years. And I know Karen you don’t give gross margin guidance per se, but can you give us some high level views on gross margin specifically. I know you mentioned utilization pricing, I think you also mentioned contract profitability focus, so anything you can offer there will be great.
So Tien-Tsin as you mentioned, we don’t give gross margin guidance and certainly don’t intend to at this point, but I think what you’re going to see is margins will bounce around a little bit during the year, a lot of it will be depending on hiring, the ramp up hiring. So as you saw in Q4 we did add about 3900 net resources. We also in Q4 gave raises and promotions related to 2017. Typically we’ve done that in Q3, so depending when we do that this year that obviously has a bit of an impact in the quarter that that happens. So our intention is to target the approximately 21% on a full year basis, but that won’t be a linear path throughout the year. It will really depend on the timing of investments that we make.
Your next question is coming from Jim Schneider from Goldman Sachs. You line is now live.
I was wondering if you could maybe provide a little more color on the revenue outlook and how that’s likely to progress through the year. First of all, does it assume that the banking and financial services revenue growth rate will continue to improve ratably through 2018, given some of Raj’s comments, and then secondly, can you maybe the comment directionally on your hiring plans throughout the year?
Jim let me try to take that. We expect revenue to unfold in roughly the same way its unfolded in past years. From a seasonality standpoint Q2 tends to be our strongest quarter from a revenue growth standpoint. Q3 a little less so, and as we get in to the holiday season in Q4 the revenue growth tends to be a little slower. So that’s kind of the pattern we expect. I don’t see anything unusual unfolding this year. I think from the financial services we don’t have significant improvement in the environment baked in to our current outlook. As Raj said, we see some green shoots, but certainly not calling a significant turnaround in that business. So that’s I would say modest assumptions baked in to our guidance for financial services for the year.
Our next question is coming from Jason Kupferberg from Banc of America Merrill Lynch. Please proceed with your question.
So we’re starting off the year here with really the same 8% to 10% topline growth outlook as last year, and obviously in ’17 you came in more or less at the top end of the forecast. So I just want to get a sense of the visibility you feel you have on the 2018 outlook today versus what you had on ’17 a year ago. I know that the visibility on the discretionary piece tends to kind of firm up more in March, April, May timeframe, but it does sound like there may be some encouraging data points among the money center banks, so just overall comments on visibility would be real helpful thanks.
Jason I would say, we set guidance sort of the same way at the beginning of the year every year. So I don’t think there is any meaningful difference at this point in – as we said here at the beginning of ’18 versus where we were at the beginning of ’17. We go through a very thoughtful process of bottoms-up almost account – an account by account forecast of revenue for the year, that’s based on our client teams’ best views of what we have in backlog plus our pipeline, plus some factor for business at this point aren’t identified. We use that same methodology every year. So I would say that our visibility at this point to 8% to 10% is the same as it was last year at this point.
Our next question is coming from Ashwin Shirvaikar from Citi. Your line is now live.
I want to ask a margin question, so if you made no other realignment type changes, how much 2018 margins go up just because you’re in a better place. And then I also have a sub-part question on margins which is at some point as the one-off actions like the alignment in structuring end, would you expect a narrowing of difference between GAAP and non-GAAP items.
Ashwin I think in terms of the 21% that we’ve guided to for 2018, I think a lot of that’s going to come from shift in the business and actions that we’ve already taken. As we’ve talked about for some time now we’ll continue to look to optimize the pyramid, the automation continues to become a bigger piece of the work that we’re doing both for clients as well internally for ourselves. So there’s a number of things that are taking shape that don’t necessarily require what I would call a realignment charge to execute on. They are just how we will manage the business going forward. So we’re very comfortable the 21% target that we’ve set for ourselves for this year.
And then as we move in to 2019, obviously we haven’t given guidance beyond 2019. But as you know today the difference between GAAP and non-GAAP is driven by a number of items including stock comp, FX gains and losses which we can’t predict. So, excluding one-time items those things will continue to be the big drivers of the difference between GAAP and non-GAAP and then from time to time there maybe one-time items, whether it be realignment or tax reform or the donation that we’re making to the US Foundation later this year. So those obviously will continue as they occur.
Our next question is coming from Bryan Bergin from Cowen & Company. Please proceed with your question.
I wanted to healthcare business, any outlook there? Can you comment on the launch of your pipeline and do you see 4Q performance somewhat as a baseline for 2018?
I think healthcare continues to do well for us, especially given all the investments that we’ve done as you’re aware of the TriZetto and now with TMG. I think as we look out in to 2018 I see that continuing. We’re seeing strong traction specially around the digital space and with interactive after modernization and just all the work around digital engineering and a very strong pipeline developing, continuing with our BPaaS deals, not just around Facets but also around TMG. And I think as you know there’s some potential mergers that are out there and I think we are positioned well for potential work that may come down in to those transactions. So I think overall the investments in healthcare serves us well and we see a strong growth in 2018.
Our next question is coming from Keith Bachman from BMO Capital Markets. Please proceed with your question.
Karen this is for you. I wanted to see if you could talk a little bit about how FX is impacting the margin guidance that you’ve given. Some of the disclosure in 10-Q would suggest that there’s a pretty strong tailwind the margins with the headwinds, the hedges you haven’t placed rather. Not clear how the dollar is impacting the margin though. But if you could just talk a little bit about FX broadly speaking in terms of the impact of the margin guidance?
Sure Keith, if you think about it there’s really three currencies that drive both top line and potentially bottom line impact for us and it’s really the pound and the euro and some of them with Swiss Franc, but the smaller impact and then the rupee. The pound and euro tend to be a natural hedge, so whatever movement we see in those currency effects bottom revenue and cost essentially in line, a little bit of a difference, but it doesn’t have a material impact to the margin line. The big driver that can impact margins is really the rupee.
But the rupee frankly has been fairly stable for the last several months; I mean it’s sort of been hovering in the 63 to 64 rupee to the dollar rate. So that’s not having a significant impacts on the margins at this point. And then as we’ve talked about in the past, we typically hedge about 50% of our rupee exposure in any given year, and that’s consistent from year-to-year.
Our next question is coming from Glenn Greene from Oppenheimer. Your line is now live.
Maybe Karen just a higher level, obviously one year later, but how are you feeling about that 22% margin goal after 19, but or worse or sort of neutral relative to the initial goal, and then just a quick update on the pricing landscape and the environment?
So I think in terms of the 20% target that we set for 2019 for non-GAAP operating margins, I say we feel neutral when we’ve set those targets to ourselves and made a commitment to our shareholders around that. We had done a lot of work in terms of how we would get there over the years. I think we are extremely pleased with the way the company performed last year and everybody really rallied around making those improvements while continuing to invest for the long term growth in the business. So I think we’ve done a great job so far of managing both revenue growth and expanding margins and I think we’re very comfortable with the trajectory that we’re on there.
I think in terms of pricing, pricing has been very stable. Very similar to the trends we’ve seen over the last few years where certainly clients are looking to continue to optimize cost if there is legacy or business as usual, environments and redirect those dollars to transformation dollars. But certainly what you’re seeing is some of the digital work and some of the more transformative work is higher value work. That is higher priced work and that is also obviously a big part of the margin shift that we’ve been seeing and expect to continue to see.
Our next question is coming from Mayank Tandon from Needham & Company. Please proceed with your question.
With the ongoing shift at digital, can you comment on the challenges you’re facing in terms of hiring the best talent and the right talent for the type of work and then the implications for wage pressure and employee attrition as you shift your talent based on more digital type work.
Mayank, its Franc I’ll touch on that. Look whenever you – you’re thinking of a key point, whenever you have these big technology transitions you do have contractions, not contractions but rather shortages in pockets of the workforce skills. That’s why we invested very heavily last year and will continue to invest very heavily this year in retraining the workforce. Last year we retrained about a 100,000 of our associates with variety of new digital skills. That’s an ongoing effort.
Digital skills are a little different than say past generations of technology because you have a number of different skills. There isn’t sort of one or two main predominant skillsets, when you talk about digital you actually have lots of skillsets, so that the ongoing training is important and we’ll continue to do that.
I do think that’s part of the reason that we have had somewhat higher employee attrition, that’s also a phenomenon we’ve seen in the past when we invest in retraining, then it becomes attractive sometimes for competitors to take people that we’ve invested in in making the training efforts. We continue to feel comfortable though that we can continue to stay ahead of that, and that the training efforts and the training engine that we have is strong.
I’d also say that a part of the reason that we announced today is the formation of the Cognizant US Foundation is to try to address this problem on a broader and a more systemic basis. We believe that the skill shortage within the US is very real and that we – given the fact that we are probably one for ourselves for Cognizant we’re probably one of the largest in-house training operations in world. That we can take some of that knowledge and externalize it and use it to train the workforce in the US outside of perhaps the traditional IT work force and use that to create new sources of talent for the entire industry.
Our next question today is coming from Edward Caso from Wells Fargo. Your line is now live.
I was curious on the size of digital engagements, are they rising, what pace are they rising at? And as they do get larger and more transformative of traditional systems, is that bringing back some of the traditional competitor. So help us with your relative positioning to your market given as the digital world evolves?
Ed its Franc, look for some quarters we’ve been seeing, now we’ve been talking about this concept of digital at scale. Certainly something that we’ve seen over the last or over 2017 that after an initial phase of call it, piloting or experimenting our clients, these new digital heavy weights that I talked about, the firms that are looking combine digital and physical that are leveraging existing assets, existing positions in industries are strongly investing in putting a digital layer on top of their physical assets and their capabilities. That’s driving larger scaled digital projects.
We think about large scale digital as projects that involve or they transform the business model, the operating model and the technology model of our clients. So that trend continues to unfold, and I think will continue to unfold through 2018. And as I said in my prepared comments, we think that there are very few companies in the world that have the end-to-end capabilities, they can work with the client on digital, all the way from strategy, all the way through execution.
And this is hard work, right. It’s not easy stuff both executing for clients, but also building the internal capabilities and stitching them altogether in a way that’s effective at the client interface. And we think that we are very well positioned because of the investments that we’ve been making not just in the last couple of years but going back a decade when we started building consulting and so on.
So over a very long period of time we’ve build strong foundational capabilities to do digital end-to-end, to do kind of large scale integrated programs for client end-to-end. And we really think there are very few companies in the world that have that range of capabilities.
Our next question is coming from Frank Atkins from SunTrust. Your line is now live.
Wanted to ask if you’ve seeing any difference in client behavior as a result of the tax changes, or if the tax changes impact your M&A philosophy at all going forward?
Let me take that and I’ll ask Raj if there’s anything to add. I think Frank its surely to tell if there have been real changes to client behavior as a result of the US tax reform, maybe I’ll give you an update next quarter if we see anything, but right now it’s just too early to tell. I don’t think there’s fundamental change to our M&A philosophy as a result of tax reform. We’re assessing that. As you know tax reform will allow us to access cash that was overseas for some period of time. That may change the geography of M&A, but I think the philosophy will remain largely where it’s been.
Our next question is coming from Arvind Ramnani from KeyBanc. Your line is now live.
I wondered to kind of really dig in to a topic. You’ve touched upon a couple of times, and as you enter this new age of compute with a richer set of technology options and also with technology strategy becoming comparative differentiator for very traditional companies. How is this demand environment changing, and have client expectations changed, and also if you can comment on how Cognizant is positioned? Specially I’m looking to see if you can comment on how you’re enriching your consulting experience, your M&A priorities and also do you feel better for the demand environment over the next two or three years, or has it made it harder to manage the business?
Arvind let me set the stage and then I’ll ask Raj to comment. Look, I think I’ve said this for a while, right, I think the macro trend here in my mind is that the world in general is becoming more technology intensive. So businesses are becoming more technology intensive, governments are becoming more technology intensive, societies are becoming more technology intensive as a result. We’re using more technology in our personal lives, we’re using more technology in the business world.
So as the world become more technology intensive that sets the backdrop for our demand environment, which is that, our clients whether those are businesses or government need access to skill, they need access to capabilities, they need to access large scale program management and governance to be able to develop, deploy, integrate all of that technology so that it actually delivers results.
So that’s the macro and then I’ll let Raj comment a little bit about the more specifics.
Arvind I think when Franc touched on it a little bit earlier, right. When you look at companies, many of our clients – digital is not just about the front end, the user experience, it’s really about being able to make changes at the business level, the operating level and as well as the technology. And there are only a handful of the companies that can make that kind of impact for the companies and provide all the governance and execution that’s behind it. And I think we are well positioned for that and we’re seeing that. As these projects become larger in scale, Cognizant continues to benefit from those.
Operator I think we have time for one more question.
Certainly our final question today is coming from Joseph Vafi from Loop Capital. Your line is now live.
May be ask the growth question one more way Franc, if you could parse out where you’re seeing growth this year, digital versus non-digital relative to that 8 to 10 points of growth that you outlined for the year, especially relative to your comments early on about legacy companies becoming digital giants. And it seems like you’re placing your bets more on the digital side and maybe versus some of the older technologies that they are continuing to deploy.
I think that as a macros it’s going to vary a little bit industry by industry. But as a macro statement our clients are going to continue I think to optimize legacy and invest in digital growth. Now having said that, I think it’s important and I’ll make this point that optimizing the legacy is still in many cases a really solid and good business for us. We know how to run clients legacy systems, we know how to optimize them, we know how to keep them up and running. And these legacy systems are still very much the backbone of our clients operations.
So they are not going away and they are very important because digital gets build on top of legacy. In fact, sometimes I say that – we talk about legacy, but actually these legacy systems are our clients’ heritage, right. And so they are really important to have that backbone. So we’ll continue to invest in that business, we’ll continue to stay very relevant there, and there’s a lot of value to be added to clients to just being able to go in and say, look, we can help you run your existing traditional legacy environment, more efficiently, more effectively, lower unit cost and so on and so forth.
On top of that, we have to continue to invest in digital to remain relevant. And so we are doing that. Our digital revenue last year grew almost 30%, 3x the company average almost in ’17. So we’ll continue to make those investments, that’s an ongoing process, but I think I can say to you with confidence that that process is well underway at this point. We are very competitive across the industries that we serve. We’ve got good differentiation, our clients look at us as very credible players in digital. So, those two trends will continue to play out in to 2018 and I feel pretty good about how we’re positioned.
And with that I think we’ll wrap up the call. I want to thank everybody for joining us today and for your questions. I would say that we are confident in our ability to deliver a strong 2018 and all of us look forward to speaking with you again next quarter. Thank you.
Thank you. That does conclude today’s teleconference. You may disconnect your line at this time and have a wonderful day. We thank you for your participation.