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Cognizant Q2 Results: Onwards and Upwards In Spite of Health Net Merger

Cognizant Q2 2015 results:

  • Revenues were $3,085.1m, up 22.6% y/y, and up 25.5% in CC
  • EBIT margin was 17.7%, down 171 bps y/y but up 50 bps sequentially
  • Adjusted EBIT margin was 19.8%, down 122 bps y/y, but the same as in Q1
  • Non-GAAP operating margin, which excludes stock-based compensation expense and acquisition related expenses, was 20.2%, slightly above the target range of 19% to 20%.

For full details, see here.

CEO Francisco D’Souza describs Q2 as a “tremendous quarter”, delivering the strongest sequential revenue growth in dollar terms in the company’s history, and ahead of guidance.  This comes on the heels of strong performance in Q1.

And guidance for Q3 and full year 2015 is upbeat, in spite of the anticipated loss of $100m in incremental revenue in H2 from Health Net. Confidence, despite the impact of the restructuring of its contract with Health Net in the light of its imminent acquisition by Centene, is strong.

Cognizant expects that its 7-year $2.7bn MSA with Health Net for BPS, whch was due to commence in H2, will not now be implemented. The relationship with Health Net for other services will, however, continue; its existing AO and BPO contracts with Health Net, valued at $520m, have been extended through 2020. Significantly, one important aspect of the agreement with HealthNet has been retained, with Cognizant licensing some IP from Health Net which it intends to leverage with TriZetto software and Cognizant hosting and BPO capabilities in the development of platform-based offerings.

Consolidation on the healthcare payer market (Centene-Health Net; Aetna-Humana; Anthem-Cigna) means (after an initial pause in decision making) there will ultimately be winners and loser among the SITS and BPS suppliers to this market. Cognizant is more likely to be a winner. With deep domain knowledge, platform-based offerings based on the Cognizant-TriZetto platform, enhanced by Health Net IP, and offshore delivery capabilities, it is well positioned for a range of both C&I and also BPaaS opportunities.

Elsewhere, Cognizant saw 18.1% y/y growth in US$ from the financial services sector, now a $5bn annual revenue run-rate business. Cognizant claims to be seeing broad-based growth both banking and insurance, with strong demand, unsurprisingly, for digital-related services. The growth is strongest for project-based services.

Cognizant does not provide segment reporting by service lines, but in its commentary stated that each of its “Horizon 2” service lines – Cognizant Business Consulting (CBC),  Infrastructure Services, and BPS, delivered higher topline growth than the company average (the slowest area is likely to be legacy applications maintenance). Management highlights that CBC is competing against Tier 1 global consulting firms in many deals. Growth in BPS is led by the insurance, healthcare and financial services sectors.

Geographically, Cognizant saw growth across all regions, including Continental Europe, which remains spotty, in particular for non-European players. Its “Rest of World” segment is primarily India and Australia. Will we see further tuck-in acquisitions similar to Cadient (digital marketing services in U.S. healthcare) or Odecee (digital services in Australia)?

An immediate challenge for Cognizant operationally is improving attrition, which is trending upwards, now at 19% annualized. This follows a hiring spate throughout 2014 and Q1 2015 (~46,000 net additions). Cognizant has been expanding its graduate recruitment in the U.S. and Europe, and one of its challenges might be improving employee engagement and retention in this cohort. Utilization is down y/y (73% offshore, 78% excluding trainees) but up sequentially. The y/y decline is attributed to workforce re-skilling initiatives; the expectation is that utilization will continue to increase, which will, of course, help drive margin.

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