Cognizant CEO: Elliott Management Deal Strikes Right Balance Among Digital Growth, Higher Margins and Larger Returns

Cognizant CEO Francisco D'Souza said the newly minted agreement with Elliott Management will lead to higher operating margins, larger digital investments and more cash returned to shareholders.

"We've thought long and hard about this," D'Souza told Wall Street analysts Wednesday morning. "We think we've landed in a good place that balances our account to invest in the business."

The Teaneck, N.J.-based company, No. 7 on the 2016 CRN Solution Provider 500, said Wednesday that 23 percent of its total 2016 revenue – or roughly $3.1 billion – came from its analytics, automation, cloud, cybersecurity and -as-a-service practices. D'Souza broke out Cognizant's digital revenue for the first time Wednesday, and said the practice is growing much faster than the company as a whole.

[RELATED: Cognizant Declares Truce With Elliott, Pledges To Appoint 3 New Directors, Create Financial Policy Committee]

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Cognizant's agreement with activist investor Elliott Management calls for the company to appoint three new independent members to its board of directors, create a Financial Policy Committee, invest more in new technology practices, target non-GAAP operating margins of 22 percent by 2019, and return $3.4 billion to shareholders in the next two years through share repurchases and dividends.

"We are excited about the plan that we announced today," D'Souza said. "We've been talking to you for some time about this shift to digital, and this really gives us an opportunity to accelerate that shift."

Cognizant shares climbed $2.09, or 3.89 percent, to $55.89 Wednesday morning. Cognizant announced its earnings and deal with Elliott Management before the market opened.

Elliott Management said in late November that it had taken a 4 percent stake in Cognizant, and called on the solution provider to buy back $2.5 billion in shares to drive up the company's stock price and shake up its board of directors, where more than half of the seats had been filled by the same people for more than nine years.

D'Souza said Cognizant will look into pivoting away from some aspects of its core business that do not meet the company's desired margin profile. While that might result in a dip in Cognizant's revenue, D'Souza said that should be offset by above-average growth on the digital side of the business.

At the same time, D'Souza reminded investors that Cognizant's core business is critical to being part of its customers' digital futures since most are building their new digital capabilities on the backbone of Cognizant's traditional systems.

In future quarters, D'Souza said Cognizant will focus on tuck-in acquisitions that will give the company more technology, industry-based or geographic capabilities. Cognizant purchased two companies in its most recent quarter, and D'Souza said the company's pace of acquisitions should continue at or above that level going forward.

Elliott Management had been calling on Cognizant to use 25 percent of its annual U.S. free cash flow as well as $1 billion in foreign cash to fund a steady pace of 14 attractive tuck-in acquisitions.

Cognizant saw sales in the quarter ended Dec. 31 jump to $3.46 billion, up 7.1 percent from $3.23 billion a year ago. That fell short of Seeking Alpha's projection of $3.49 billion.

Net income dipped to $416 million, or 68 cents per diluted share, down 1.9 percent from $424 million, or 69 cents per diluted share, last year. On a non-GAAP basis, though, earnings jumped to 87 cents per diluted share, up 8.8 percent from 80 cents per diluted share a year ago. This edged out Seeking Alpha's earnings estimate of 86 cents per share.

On a full-year basis, sales rose to $13.49 billion, up 8.6 percent from $12.41 billion a year ago. Net income, however, fell to $1.55 billion, or $2.55 per diluted share, down 4.4 percent from $1.62 billion, or $2.65 per diluted share, last year.

Cognizant's financial services segment saw 3.5 percent year-over-year sales growth to $1.35 billion as an increased focus on digital, cloud, automation and application development was offset by continued macroeconomic challenges, according to Cognizant President Rajeev Mehta.

Health-care segment sales grew 5.6 percent from $1.01 billion due to a slight uptick in discretionary spending around digital transformation and value-based initiatives, Mehta said.

Sales for Cognizant's retail, manufacturing and logistics segment increased 12.6 percent to $688 million. And sales from all other operations improved 14.6 percent to $415 million.

On a geographic basis, Cognizant's North American sales increased 7.2 percent to $2.72 billion, while sales from Continental Europe skyrocketed 21.9 percent from $262 million due to the ramp-up from recent wins in Germany, France and the Nordics, Mehta said. Sales in the United Kingdom, however, fell by 10.8 percent to $273 million.

Revenue from the rest of the world increased 17.8 percent to $212 million due to an acceleration in digital transformation initiatives among customers, Mehta said.

For the coming quarter, Cognizant expects to deliver non-GAAP diluted earnings per share of at least 83 cents per share on sales ranging between $3.51 billion and $3.55 billion.