Cognizant sees non-GAAP OPM at 19-20% going forward

Leading global IT and BPO services provider, Cognizant has delivered a spectacular set of numbers. Its topline has grown 10% sequentially and has increased nearly USD 77 million in a quarter, the highest ever in its history.
In an interview with CNBC-TV18, Francisco D’Souza, President and CEO of Cognizant spoke about the results and his outlook for the company.
Here is a verbatim transcript of the exclusive interview with Francisco D’Souza on CNBC-TV18. Also watch the accompanying video.
Q: What have been the key drivers for growth this quarter – 10% sequential growth is stunning to say the least, has it been broad based, across verticals in geographies?

A: We had a very-very strong quarter. In terms of sequential revenue addition, it was our strongest quarter in the history of our company. What was truly gratifying to us was the fact that as you mentioned this was a story of growth across industry verticals, a story of growth across our service lines and the story of growth across each and every one of our key geographies. So, it was a very strong quarter across the board.

Q: How would you describe your performance on the operating margin front if I can just take us to your press release, you are talking about 19% on your operating margins. Have cost cutting measures resulted in margin expansion? Do you think this kind of margin is sustainable?

A: The real number to look at from a Cognizant standpoint is our operating margin on a non-GAAP basis which excludes employee based stock compensation expense and the India fringe benefit tax impact. That number was a little over 20%. Our target range for that is 19-20%.
We have a strategy at Cognizant of re-investing in the business.
So, we manage the business to operating margins between the 19-20% range on a non GAAP basis. We take every dollar above that and reinvest it in the business for growth. Part of the reason that you saw such strong growth this quarter was a direct result of our strategy of reinvesting in the business.
And what you see is that we will continue to maintain margins in the 19-20% on a non-GAAP basis. We over performed that a little bit this quarter, but we will continue to maintain in the 19-20% range going forward so that we continue to invest for growth in the business.

Q: Some analysts have expressed concern about whether this kind of 10% sequential growth quarter on quarter is really maintainable. What sectors or verticals are you really betting on for future growth?

A: Like we said a few minutes ago on our call with investors, we are actually guiding to a 3% growth ion the fourth quarter because we think that as we go into the third quarter with a little bit of uncertainty around budget and so on and so forth that the pace of decision making that we saw in the third quarter will actually slow a little bit.

Having said that, because our growth in the third quarter was so broad based, we expect to continue to see healthy growth in the medium and long term across all of our industry segments. Clients are telling us in financial services that the worst is behind us at this point and that financial services clients are starting to return to spending. There is a lot of spend being driven by merger integration work that needs to happen as a result of the big banking  mergers that we have seen over the last couple of quarters.

In our healthcare business, which is another significant business for Cognizant, we are seeing growth there being driven by increasing pressures on the life sciences side as those companies come under increased pressure from competition. But we are also seeing growth in the healthcare insurance side of our business which is related to regulatory changes coming around as a result of the many regular changes that are happening in the health insurance industry. So, we see growth across the board as we go forward.
Q: When you say that the clients are saying that the worst is behind us do you expect a positive rub off as far as growth in the volume front is concerned? Do you expect pricing pressures to decrease?

A: This quarter virtually all of our sequential growth of 10% was driven by volume. This was a volume driven quarter. Our pricing was flat for the quarter. So this was clearly a volume based growth and we expect to see that continuing. Pricing was stable and we expect the pricing environment to continue to remain stable going forward.

Q: How do you manage the currency fluctuation as well especially with the dollar getting hammered quite a bit? After you did the UBS deal, Mr. Lakshmi Narayanan said as long as this volatility is manageable; our hedging programs are in place. Do you still hold that view given the fact that the dollar is still getting hammered?

A: Currency volatility just adds another dimension of complexity for us to manage in terms of the business. But as Lakshmi said, and I concur with that, we have a hedging program, which we put in place and it does cushion us to some extent from the volatility of currencies. But given the movement not just of the dollar relative to the rupee but all of the other currencies in the world we are watching that very carefully and we will continue to monitor that and pay close attention to the currency movements.
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Q: How is the integration with the UBS BPO coming along? Is that on track?

A: It’s a little early to talk about that. We don’t expect the deal to close before the end of this year. So it’s a little early to talk about integration at this point. But we are very excited about the transaction. We have got to know the UBS team very well over the last months as we have worked with them and now increasingly working with them much more closely. We have a lot of respect for them as professionals. But more importantly and more equally importantly we think that there is a large opportunity for us to take the capability of the UBS centre in Hyderabad and offer it to our other banking and financial services clients. So we are very exited about that possibility.

Q: What kind of other inorganic growth opportunities are you exploring? What kind of cash would you have on books? Are you hungry for more acquisitions at this point?

A: We had a very strong quarter in terms of cash generation. Our cash short term and long term investments at this point stand in excess of USD 1.3 billion. So we’ve got a significant strength of the balance sheet to be able to look at acquisitions. But our acquisition strategy remains unchanged at this point. We have always said that we are focused on tuck-under acquisitions, very focused targeted acquisitions that add specific capability or competency to Cognizant. That was the case with UBS as we just talked about, it was also the case with another company called Pepperweed Advisors, which bolstered our IT and infrastructure services business.
So we are going to continue to look for such tuck-under acquisitions. We think they are terrific. We have done several of them over the course of our history. They have been very successful for Cognizant and we think it’s a great way to grow the business, add capabilities, bring on newer service offerings for our clients, and it’s a win all around. So that continues to be our approach to acquisitions.

Q: What about hiring and wages? Does this kind of growth give you greater levy in terms of your hiring strategy and what kind of wage inflation have you factored-in?

A: We have a philosophy at Cognizant that when we are successful we share that with our employees. We think that is very important in the end. Our employees are what make the successes at Cognizant possible, 10% sequential growth would not have been possible but for the efforts of our 68,000 employees around the world. I’d like to thank all of them for that.
Part of the way that we thank our employees for that work is by sharing the over performance. So we have accrued a very healthy variable pay, we pay very healthy bonuses this year for 2009 as we go through the year. We have made very significant provisions for that in this quarter.
In Q3, we added a net of almost 4,000 people. So, we grew the company by close to 4,000 people. We are very pleased that in a couple of weeks we will be going on campus in India to start recruiting for 2010 class of campus hires. We expect that by the middle of next year, all of the 2009 hires and offers that we made will be fully on board at Cognizant. So, we have plans to continue to hire both at the campus level and laterally as we go forward.