Cognizant Technology Solutions Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
November 1, 2023

There are 9 speakers on the call.

Operator

Ladies and gentlemen, welcome to the Cognizant Technology Solutions Third Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. Thank you. I would now like to turn the conference over to Mr.

Operator

Tyler Scott, Vice President, Investor Relations. Please go ahead, sir.

Speaker 1

Thank you, operator, and good afternoon, everyone. By now, you should have received a copy of the earnings release and investor supplement for the company's Q3 2023 results. If you have not, copies are available on our website cognizant.com. The speakers we have on today's call are Ravi Kumar, Chief Executive Officer and Jan Siegmund, Chief Financial Officer. Before we begin, I would like to remind you that some of the comments made on today's call as described in the company's earnings release and other filings with the SEC.

Speaker 1

Additionally, during our call today, We will reference certain non GAAP financial measures that we believe provide useful information for our investors. Reconciliations of non GAAP financial measures where appropriate The corresponding GAAP measures can be found in the company's earnings release and other filings with the SEC. With that, I'd like to now turn the call over to Ravi. Please go ahead.

Speaker 2

Thank you, Tyler. Good afternoon, everyone. Today, I would like to cover 3 topics: our 3rd quarter results, the demand environment and a brief update on our strategic priorities. We are pleased with the company's continued progress in the 3rd quarter, during which clients remained cautious amid economic uncertainty and discretionary spend was under pressure. Q3 revenue came in at $4,900,000,000 within our guidance range.

Speaker 2

We saw sequential revenue growth of 20 basis points. Year over year revenue grew 0.8% as reported or a modest decline of 20 basis points in constant currency. Our adjusted operating margin of 15.5 percent exceeded our expectations, mostly reflecting savings from our Next Generation program, which remains on track as well as from our operational discipline and the timing of spend on investment opportunities. We recorded another quarter of bookings growth, up approximately 9% year over year. We ended Q3 with record Trailing 12 month bookings growth of $26,900,000,000 up 16% year over year and a strong book to bill of 1.4x.

Speaker 2

We have sustained our large deal momentum through Q3. Approximately 30% of our in quarter Q3 bookings were large deals and 3 of these deals exceeded $100,000,000 each. I believe we are getting progressively better at building a creative Deal Generation Engine and Solutioning Large Deals. I am especially encouraged to see our continued decline in attrition. Trailing 12 month voluntary attrition for our Tech Services business declined to 16.2%, down about 4 percentage points sequentially and down 13 points year over year.

Speaker 2

This decline in attrition was a positive factor in our just completed annual Client Net Promoter Score survey, which showed significant improvement year over year and hit a historic high for Cognizant. Clients let us know that leadership, account management and delivery are especially important to them. And the survey results show that in these areas, we're doing a great job. This assessment of how clients perceive Cognizant underscores the interdependence of the employee and client experience that gives us confidence that the changes we are making will help Quick word about Financial Services. We continue to reposition our Financial Services segment while responding to an increasingly challenged demand environment.

Speaker 2

One of the ways we are striving to reinvigorate growth is through a sharply focused sub industry go to market approach in the Americas. Directly by highly experienced leaders, we believe this change will increase our agility and deepen our domain expertise. Let's turn to the demand environment and what I'm hearing from clients. Clients remain focused on efficiency reduce costs and consolidate providers as they increase their productivity and resilience and we are helping them do so. This should in turn enable them to underwrite their continuing investment in digital transformation.

Speaker 2

For example, during the quarter, we Plan to support their operations through automation and infrastructure management. We also established a new multi year relationship with Swedish firm Interim, we expect to provide end to end digital integration and core modernization services for their credit management technology platform. To dive deeper into clients' long term objectives and discover new ways to strengthen our partnership with them, Cognizant held a 2 day Discovery Summit last month For about 1 30 of our North America clients, our first large scale client gathering in more than 4 years. We discussed the transformative power of generative AI and how we believe it can reshape every industry. We showed clients how to apply generative AI to Create more connected, collaborative and responsive relationships with their customers.

Speaker 2

We also ran live use cases at Cognizant's neural AI platform, As mentioned last quarter, we expect to invest approximately $1,000,000,000 in our generative AI capabilities over the next 3 years, focusing on areas such as platform modernization, infrastructure, recruiting and upskilling. To that end, we opened a dedicated AI Innovation Studio in London. And later this year, we expect to open AI Studios in New York, Dallas and Bangalore. We have trained about 55,000 of our employees on generative AI this year and have an additional 40,000 employees from all levels of our company Registered and pursuing training on GenAI. We have also invested in AI partnerships and experimental infrastructure to support early client engagements.

Speaker 2

We believe clients will depend on partners like Cognizant to generate significant productivity gains through automated AI powered platforms for design, engineering and operations. This shift in client behavior further validates our recently refined strategy, which is aimed at strengthening Cognizant's differentiation to help drive growth. Our strategy is focused on 3 imperatives. 1st, we are resolved to be an industry led Creating value for clients by integrating technology with industry use cases to drive business outcomes. We are embedding industry across our value chain and select industries, we are developing more enterprise scale platforms designed for industry and operational use cases.

Speaker 2

Partnerships have a major role to play here. We are focused on expanding our partner ecosystem across a range of technology providers, among them Transformation, we believe this strategy as a full stack provider opens new and significant managed services opportunities. 2nd, given today's more heterogeneous technology landscape and the desire of many clients to build their own technology muscle, we focus on operating A highly flexible business model to meet clients where they are in their digital transformation journeys. We can support them across a range of Project types, whether that's structured deals, traditional managed services, build operate transfer, co innovation, partner solutions or large And to help clients strengthen their technology expertise, we can either lend our human capital along with our human capital value chain, which includes learning, development, automation and AI infrastructure and more. Our business model flexibility is well suited to the changing nature of large deals where we see increasing demand for bundling services, Often a combination of software, people take over infrastructure and services.

Speaker 2

These deals have a potential to bring Cognizant into the heart of clients' business Putting us in a strong position to capture future services opportunities. Our third imperative is to Enable more intimate levels of client collaboration and co innovation. This effort grows out of our heritage of client centricity and grassroots innovation. Given the scale and diversity of our global teams, we believe we have a potential to harvest an abundance of ideas, big and small, that can contribute to our clients' focus. Inspired by our Blue Bolt's Grassroots Innovation Movement launched in quarter 2, more than 35,000 of our employees have generated 75,000 ideas.

Speaker 2

We've already implemented about 14,000 of these ideas, nearly 6,000 of which are client facing. Our strengthened ability to co innovate with clients is valuable as the grapple with understanding and applying generative AI. During the quarter, we launched Telco Assurance 360, a cloud based AI powered built on ServiceNow and designed to provide telcos with real time visibility into network issues and fast proactive resolution through AI powered analytics. We also signed a multi year agreement with a leading provider of digital and cloud enabled solutions that are vital to the of Health and Human Services Programs across the U. S.

Speaker 2

Cognizant will serve as the client's sole global IT services and operations partner to help Drive Transformation at Scale. We also provide the client with access to our AI, machine learning and generative AI tools along with to advance revenue growth, increase administrative efficiency and improve the member experience. What's more, we are expanding our Strategic collaboration with Qualcomm Technologies to jointly implement AI based solutions at the edge as a part of our car to cloud initiative. We encourage our clients who want to transform their businesses by being AI first to begin their journey by modernizing the data Tekture Cloud Infrastructure and Core Business Applications. Today, we are running more than 150 plus early client engagements that incorporate the use of generative AI.

Speaker 2

Some of the examples of this work include general productivity use cases related to writing code, Code analysis and troubleshooting, knowledge management and translating product specs into natural chat or speech. Business specific use cases for call center automation, product prototyping, audience prediction, Claims Management, Medical Scribing and Research and Development And domain specific use cases like onboarding new employees, validating deed documents and financial statement planning analytics. We have 300 plus additional opportunities in our pipeline that we are planning to scale. Let's turn to a quick update on our 3 long term strategic Starting with becoming an employee of choice in our industry. I see Cognizant as a human capital company first And a technology company, 2nd.

Speaker 2

Everything we do hinges on the quality, dedication and scale of our talent base. That's why it is so consequential that our voluntary attrition continues to fall, putting us on par with the industry average. We expect further improvement in our attrition in quarter 4. It's also worth noting that in quarter 3, we had a net sequential headcount increase for the first time in several quarters. As a human capital company, we are determined to help improve the lives of workers around the world.

Speaker 2

With that in mind, we announced a groundbreaking training initiative yesterday called Cognizant's Synapse initiative. Our job training endeavor It's aimed at empowering more than 1,000,000 individuals with advanced technology skills, including generative AI and that they will need to thrive in the digital economy. We intend to build a consortium of partners for training and jobs, which will then employ individuals who have upskilled through our Synapse initiative. Our next performance objective is to accelerate revenue growth. When I joined Cognizant in January, I said large deals are one of my top priorities.

Speaker 2

As I mentioned earlier, we are pleased to see our continuing large deals momentum, which is underpinned by the work we are doing to The capabilities required to seed, shape and sell large deals and our ongoing investment in the client facing roles needed for driving growth. These efforts have helped to partially offset what remains a softer discretionary spending environment and provides new growth opportunities following last year's muted bookings growth. Our 3rd performance objective is to ensure operational excellence across the company. We remain focused on simplifying our operations, including our sales and delivery structure, so we can continue to become more agile and get closer to clients in their unique business challenges. In general, we are operating with fewer layers, optimizing our day to day operations with enhanced system and tools and working to streamline our processes and automate information flows using AI.

Speaker 2

Differentiation in the tech services industry happens at on the project level, making relationships and strong execution key. That's why I've invested so much time in meeting with over 2 70 clients so far this year, building trust and learning all I can about Cognizant can deliver more value to them. Over the past three quarters, I believe Cognizant has made meaningful progress on our long term priorities. While we have a lot of work ahead, we also have much to be proud of. This includes a continuing large deals momentum improved employee and client satisfaction scores, declining attrition, the scaling of our industry leadership with a platform Centered approach, heightened operational discipline and the launch of a grassroots innovation movement.

Speaker 2

Looking ahead, we believe the soft demand environment is unlikely to see a rapid rebound. Therefore, we expect clients to continue tempering the discretionary spending as they begin the New Year. Given that market reality, we remain focused on winning led large deals aimed at cost takeout and vendor consolidation, which can offset current pressure on discretionary spending. Our focus on operating discipline and our year to date progress on the NextGen program gives us confidence that we can meet our expectation to deliver our 20 to 40 basis points of margin expansion next year. Jan will share more detail on NextGen in a moment.

Speaker 2

Taking a longer view in my read of business history, periods of great uncertainty and periods of change rarely coincide. Today, I believe we are in Just such a period of simultaneous great uncertainty and deep seated change. The uncertainty is being compounded by a number of With immense power such as generative AI, which I believe could become as ubiquitous and consequential for business Society, as the Internet did 3 decades ago, I expect this reality will leave most clients, However focused they are on navigating uncertainty with no choice but to make some big bets if they are not to be left behind by the peers. I believe Cognizant is in a position in a great position to prepare them for this future, whether by helping them achieve significant savings to underwrite investments in transformation or by helping them build their own technology muscle, which can include becoming fully AI ready. In closing, you are all aware that we recently appointed Jatin Dalal to be Cognizant's next Chief Financial Officer, We're excited that he will be joining us in December.

Speaker 2

Since this is Jan's last earnings call with Cognizant, I want you all to know that What a powerful partner he's been to me across so many dimensions, strategic, financial, operational and cultural. He left a positive and indelible mark on our global organization, and I'm especially grateful that he agreed to stay with us until early next year to ensure smooth transition to Jatin. With that, I'll turn the call over to Jan to provide additional details on this quarter.

Speaker 3

Thank you, Ravi for the kind words. I want to thank all of our associates around the world for welcoming me into the Cognizant family 3 years ago And for making my time here such a memorable experience. It has been a pleasure working with so many great people at Cognizant And all of you on this call, I'm confident that I'm leaving the company in great hands with Jatin, Who many of you know is an accomplished CFO and an experienced IT Services Executive. Over the next several months, I look forward to working with Ravi, Neptjatin and the rest of the leadership team to ensure a smooth transition. With that, let's turn to our 3rd quarter results.

Speaker 3

We delivered revenue within our guidance range despite A soft discretionary spending environment and ongoing economic uncertainty. Adjusted operating margin exceeded our expectations, Reflecting savings from our next gen program and the timing of investments, which is driving some modest upside in our guidance That I will touch on later. We were also pleased to deliver another quarter of solid bookings growth, which continue to be driven by larger, longer duration engagements. Moving on to the details of the quarter. 3rd quarter revenue was $4,900,000,000 an increase of 0.2% sequentially.

Speaker 3

Year over year revenue grew 0.8%, but declined 0.2% in constant currency. Year over year growth includes approximately 110 basis points of contributions from our acquisitions. Similar to last quarter, our 9% quarterly bookings growth was driven primarily by larger and longer duration deals. On a trailing 12 month basis, duration is up over 50% from the prior year period. At the same time, we are continuing to experience softness in the smaller short duration contracts, driven by weak discretionary spending.

Speaker 3

This dynamic has negatively impacted our near term revenue, but we believe will put us in a better position accelerate revenue growth in the future when discretionary spending improves. Moving on to segment results for the Q3, where all growth rates discussed will be in year over year in constant currency. Within Financial Services, Revenue declined 4%, reflecting the softer demand environment across regions and sub industries. This decline was partially offset by the benefit from the resale of 3rd party products in connection with our integrated offering strategy that Ravi mentioned earlier in his prepared remarks. Looking ahead, we believe the market remains challenging, And we expect the macroeconomic uncertainty will again have a meaningful impact for this segment in the 4th quarter.

Speaker 3

That said, we are working hard to correct what is in our control, and I believe we can make meaningful progress under the new sub industry go to market approach and leadership. Health Sciences revenue declined 1%. Growth was negatively impacted by a large renewal that we signed earlier this year with a payer customer, which resulted in a lower revenue run rate, but meaningfully improved profitability. In addition, Several of our larger customers have been impacted by their own company specific and end market challenges, which has in turn led to softer discretionary spending. Products and Resources revenue grew less than 1%, Reflecting the benefit from recently completed acquisitions, strong performance from utility clients, driven by their grid modernization investments and growth among automotive clients in Europe.

Speaker 3

Growth in these areas was partially offset by Pressure and Manufacturing. Communications, Media and Technology revenue increased 7%, reflecting the benefit from recently completed acquisitions and the ramp of new contract awards. This includes the expansion of current engagement with our largest customers in this portfolio, who are launching innovative vertical solutions and leveraging our expertise in these areas to rapidly scale globally. Continuing with year over year revenue growth in constant From a geographic perspective in Q3, North America revenue was down less than 1%, driven by declines within our Financial Services and Health Sciences portfolios. This was partially offset by growth in CMT and Products and Resources.

Speaker 3

Our Global Growth Markets or GGM, which include all revenue outside of North America, Grew approximately 1%. Growth was led by Europe, which grew 3% and included strong growth within CMT, Life Sciences customers within our Health Sciences segment and Products and Resources. Finally, The resale of 3rd party products contributed 120 basis points to our overall revenue growth in Q3, the majority of which was in the Financial Services segment. Now moving on to margins. During the quarter, we incurred approximately $72,000,000 of costs related to our NextGen program.

Speaker 3

This negatively impacted our GAAP operating margin by approximately 150 basis points. Excluding this impact, adjusted operating margin was 15.5%. Similar to last quarter, Our adjusted operating margin included the negative impact from increased compensation costs attributable to our 2 merit cycles over the last 12 months. This was partially offset by savings from our NextGen program and tailwinds from the depreciation of the Indian rupee. Our GAAP tax rate in the quarter was 26.8%.

Speaker 3

Adjusted tax rate in the quarter was 25.7%. Q3 diluted GAAP EPS was $1.04 and Q3 adjusted EPS was 1.16 Now turning to the balance sheet. We ended the quarter with cash and short term investments of $2,400,000,000 For net cash of $1,700,000,000 DSO of 77 days increased 2 days sequentially and 3 days year over year. Free cash flow in Q3 was $755,000,000 Which brings year to date free cash flow to approximately $1,400,000,000 For the full year, During the quarter, we repurchased 4,000,000 shares for $300,000,000 under our share repurchase program and returned $147,000,000 to shareholders through our regular dividend. Year to date, we have repurchased approximately 11,000,000 shares for about $700,000,000 At quarter end, we had $2,100,000,000 remaining under our share repurchase authorization.

Speaker 3

Turning to our forward outlook. For the Q4, we expect revenue in the range of $4,690,000,000 to $4,820,000,000 representing a year over year decline of 3.1% to 0.3% or a decline of 4% to 1.2% in constant currency. Our guidance assumes currency will have a benefit of approximately 90 basis points as well as an inorganic Our Q4 revenue guidance range is wider than our historical practice, reflecting a heightened level of uncertainty regarding client discretionary spending and recent pace of decision making heading into The end of the year. For the full year, we expect revenue will be in the range of $19,300,000,000 to $19,400,000,000 which is down approximately 0.7 percent to flat, both as reported and in constant currency, as we do not expect a material impact from foreign exchange rates. This compares to our prior guidance range of $19,200,000,000 to $19,600,000,000 or negative 1% to plus 1% growth in constant currency.

Speaker 3

We still expect inorganic contribution to be approximately 100 basis points. Our NextGen program remains on track and our assumptions for cost savings are unchanged from last quarter. I'm also pleased to share that we are further reducing our expectations for next gen costs. We now expect to incur $300,000,000 in total charges versus $350,000,000 previously. With $200,000,000 with this year versus $250,000,000 previously, the reduction is a result of lower real estate cost As we are now as we now expect to incur about $100,000,000 related to the net consolidation of office space in 2023 versus $150,000,000 previously.

Speaker 3

This reflects lower expected third party costs associated with the real estate exits. As we have spoken about previously, we still intend to reinvest the majority of the next gen savings and growth opportunities in 2024 and beyond. Moving on to adjusted operating margin, we are modestly increasing our guidance to 14.7%, which is the high end of our prior range. As a reminder, Our Q4 operating margin is typically seasonally lower than Q3 levels. We still anticipate 2023 interest income of approximately $115,000,000 and an adjusted tax rate of 24% versus the range of 23% to 24% previously provided.

Speaker 3

In addition, we now expect To deploy approximately $1,000,000,000 on share repurchases in 2023 versus our prior expectations of approximately $800,000,000 which assumes an additional $300,000,000 of share repurchases in the 4th quarter. In total, we expect to return approximately $1,600,000,000 to shareholders through share repurchases and dividends in 2023. Our guidance for shares outstanding is unchanged at approximately 506,000,000 This leads to our full year adjusted earnings per share guidance of $4.39 to $4.42 versus $4.25 $4.48 previously, reflecting our updated expectations for revenue and adjusted operating margin. With that, we will open the call for your questions.

Operator

Thank you. We will now be conducting a question and answer session. Thank you. Our first question comes from the line of Bryan Bergin with TD Cowen. Please proceed with your question.

Speaker 4

Hi, good afternoon. Thank you. So I appreciate you offering the early commentary on the 2024 margin expansion potential. I just want to clarify first that that's Off the base of that 14.7 percent raised adjusted margin here. And then understanding The environment is quite dynamic, but based on what you're seeing in bookings activity and deal duration and backlog behavior and pipeline, Can you share any thoughts or guardrails for 2024 growth now as well?

Speaker 3

Yes. So Brian, I'll catch the easy one first. Yes, the reaffirmation of our intent to expand our margins 20 to 40 basis points is up midpoint of our expectation or our point of landing at 14.7. So that's a good assumption. The bookings momentum, Ravi might be giving you a little bit of color around what we're seeing in the market.

Speaker 2

Yes. So Brian, I've been saying this for the last 2 quarters and this quarter as well. Our deal momentum and our bookings momentum is very strong. We are continuing to see good traction. I've spoken about 2 swim lanes.

Speaker 2

There is a swim lane on transformation led deals and I've spoken about cost efficiency, Vendor consolidation, efficiency led kind of deals. We see more in this category versus the transformation, but we also see this category underwriting the savings to the transformation. So a lot of times Remember, one of the things I spoke on my early in my initial remarks is this is a period of uncertainty and change coming together. So clients are navigating the 2. There is change, significant change ahead of us and clients are wondering who funds the CapEx cycle.

Speaker 2

So The ability to take cost out and underwrite the savings to the transformation, I think is a great template and I think we are well positioned for that. What happens in the short run though is the discretionary spend has really fallen over the last three quarters. I mean, it's been very, very soft. So the deals we have won in the 1st and the second quarter, we have to backfill that as well as You know that large deals actually come with a gestation period to get to the peak levels of their potential. So we are hopeful that the large deal momentum continues.

Speaker 2

It continues over the next year. And of course, the deals we won this year will Contribute more to the next year? What I don't know is what happens to discretionary spend. I mean, the environment is very soft. So we'll have to wait and see how the discretionary happens, but I'm very optimistic about how the large deal momentum is, especially on cost takeout, vendor consolidation, Efficiency led deals that we are seeing across the spectrum, and I think we are winning well.

Speaker 2

You can see the bookings momentum this year. So the one which is unknown is discretionary. That's the piece we are not sure of. Hopefully, As these deals stick as the cost takeouts continue, they kind of trigger CapEx cycles For transformation, hopefully that happens and if that happens, we are going to catch it early on.

Speaker 3

Okay,

Speaker 4

understood. And my follow-up here, just on

Speaker 3

the resale piece of the

Speaker 4

3rd party products, I think you mentioned 120 bps in the quarter. How does that compare to maybe the average over the last 4 to 6 quarters? And are you assuming resale amounts in the forward outlook?

Speaker 2

Yes. So Brian, I had spoken about a strategy of large deals with all in all swim lanes, All the way from productivity to people takeover to Software led to efficiency led, and I've spoken about it that our participation is going to be in all of them. Sometimes what happens in these situations is you have upstream software coming And you have downstream services coming in. And it's the timing. I mean, for software upstream, there is significant downstream Services, which is attached to it.

Speaker 2

So we've had 60 basis points before in the year than we have Added in this quarter, but what you really have to look at is the timing of these deals. Now In quarter 2, we announced a strategic partnership with ServiceNow for $1,000,000,000 a joint partnership. And we have an offering which actually has a bundle of software reusable assets, Services attached to it. And it is a managed services model. And that's the opportunity we are pursuing.

Speaker 2

And as these large deals come, you're always going to see the timing in one particular quarter. You could have software in the particular quarter. You could have services downstream. So That's the process of how you see this. Sometimes there are people takeovers, sometimes there is asset takeovers, sometimes There is productivity upfront and effort upfront.

Speaker 2

Sometimes you have transition upfront and you have services on the downstream. So it's hard to Pick which quarter you're going to see this, but the nature of large deals gives you That flow, if I may, in terms of how they get constructed quarter on quarter.

Speaker 4

Okay. I appreciate the detail. Thank you.

Operator

Thank you. Our next question comes from the line of Ashwin Shirvaikar with Citi. Please proceed with your question.

Speaker 5

Thank you. Hi, Ravi. Hi, Jan. Hi. I guess before I start, Jan, I guess, if this is going to be your last earnings call, thank you for all the work and effort over the years.

Speaker 5

The question is, Ravi, since you come to Cognizant, you made a number of changes. You talked about the large deal infrastructure. It seems to be in a good place. But how would you rate Cognizant's ability to win and be in the discretionary work that isn't there now, but you will need to be competitive in there When it does come back because that it seems to me is going to be the difference next year between The low single digits and mid single digits?

Speaker 3

Yes. I'll give a little bit of an answer, but I think Ravi will be Adding much more color to this. The overall position that we have in with our clients, I think, has Really meaningfully improved over the last 3 or 4 quarters. We have In the net promoter scores that Ravi was reporting on is kind of really the statistical average of this coming in at a historic high. But we can just See from the comments and the number of escalations is another one.

Speaker 3

We haven't talked in the call about it, but obviously that has been in parallel coming down. So the Service quality has been better. That's partially fueled by a low attrition rates. So the overall relationships that we have with our clients have really Very meaningfully improved. And I think we have embraced kind of a philosophy of meeting the client where the Client has needs and right now the needs are more on the structural cost improvement and productivity type, vendor consolidation type deals And discretionary spending has taken the back row.

Speaker 3

We want to be there for our clients when that discretionary spend comes and the transformative And deals are popping up and going part of it. So we're going to be having deep relationships with our clients and I focus on client relationships and feel we should be ready for that to do so. Ravi?

Speaker 2

Yes. So thank you, Jan. I think very well said. Sashfin, thank you for the question. You're absolutely right.

Speaker 2

This is the large deals muscle is consistently improved over the last three quarters. This is something which did not exist before. I came in, in January and built that muscle, and I'm very confident that we can sustain it. We've sustained it for 3 quarters, and we're very confident we can do that for the future. And we have actually now invested on institutional infrastructure to support it all the way from productivity to automation infrastructure The classical levers, which you apply in managed services and cost takeout kind of deals.

Speaker 2

We did have good muscle on discretionary before. I mean the transformation infrastructure of the company is strong. As the spend comes back, I'm very confident that because we have good engagement with our clients, We are also going to naturally be the providers for discretionary spend. You could in some ways use the strength of Our current deal momentum to support the discretionary the historic discretionary muscle of the company. Now I think Jan raised the important point, which I think is very, very important.

Speaker 2

We ran the Net Promoter Score survey this year, And we have historic high scores. And there are 3 or 4 things which have come out of that. Our attrition rates have gone down. They've gone down and they're trending downwards, even into the next quarter. Our employee satisfaction scores are on an all time high.

Speaker 2

Our client satisfaction score is on an all time high. Customers are engaging with us much more over a variety of Which means when the discretionary comes back, each of the swim lanes is going to contribute back to that back to the Strength of those relationships. So in fact, one there's one thing which really registered with me on the Net Promoter Score survey, Which is about our customers saying Cognizant is back in some form. I'm paraphrasing it, Cognizant is back or the Mojo is back. I think that is the momentum which will allow us to get back the discretionary spend as and when our customers start to spending it.

Speaker 2

So I think we have set the foundation, very strong foundation. The two things which our clients have spoken about, as I said, Cognizant is back. The second is We have a much more stable leadership, good execution, agile responses And much lower significantly much lower turnover of employees. And these would actually rub off On the discretionary as it comes back.

Speaker 5

Good to hear. The second question, again, It's a good job on the margin performance. The question I have is on the deals that you are signing, You mentioned that there is now need to be flexible in terms of structuring, in terms of bringing various partners together and so on and so forth. Does any of what you are doing today to get new deals affect How you think of future margin potential?

Speaker 3

Yes. So when we Sign up the deals, obviously, they are in a competitive environment and we apply a disciplined approach to those deals In order to keep a balance of growth and continued margin expansion. And It played out this quarter, Ashwin, really to the benefit of the margin because we had anticipated some investments a little bit stronger than we We needed in this quarter on, for example, investments into larger deals with maybe initially lower margins and And we didn't need those investments. So I think this view that we have about very carefully layering our large Steel portfolio and supporting it with disciplined approach on non billable and administrative cost It's playing out and I think we're entering that year, next year with that confidence that, that balance It's intact. And I think I mentioned it in a prior call, in the large deal expected Business profile that we do have deals that we expect to exhibit lower margin profile, but we also have deals that I have very meaningfully actually renewals of historic deals that have very meaningfully improved our gross margin profile Jason, so in the net profile, the impact has been actually more muted.

Speaker 3

And that may not continue all into the future, but for now, it has A very balanced outcome, I would say.

Speaker 2

So Ashwin, we are the first thing We just changed as we are participating on deals across the swim lanes that we spoke about. And we are competitive enough And we have built the institutional infrastructure to support execution and actually better our performance To the metrics which we commit when we win those deals. So we have to keep strengthening that. This is always work in progress. We have to continue to stay competitive and we have to continue to price them to Win and deliver them to margins, as I call it.

Speaker 2

And we continue to keep our competitiveness by strengthening our productivity tools and Our automation tools and our AI tools. So this is an ongoing process and you have to keep You have to keep changing the baseline because as you want to be competitive, you have to continue to keep working on the productivity levers. Unlike in the past, These productivity levers were labor oriented or I would say they were classical. Now they are technology oriented and hence We have a unique opportunity to create some non linearity. In the past, We did not participate in these deals.

Speaker 2

Now we are participating and winning them. So the confidence has been really high.

Speaker 5

Thank you both.

Operator

Thank you. Our next question comes from the I have Jason Kupferberg with Bank of America. Please proceed with your question.

Speaker 6

Hi. Good evening, Ravi and Jan, this is Tyler DuPont on for Jason. Thanks for taking the questions. I wanted to ask about the demand environment You're seeing as we start as we look into the end of 2023 and as we start to look into even the beginning of 2024, When looking at the updated revenue guidance being narrowed, I'm just curious what incremental trends you've seen over the past of months, whether that's changes in win rates, ramp times or softness, whether that's particular service offering, vertical geography, anything like that, that may be driving the additional cautious stance?

Speaker 2

I think the cautiousness is related to The uncertainty around the discretionary spend, I think everybody in the market is facing it, including us. What we are certain is our deal momentum and our large deals and our bookings continues to be very vibrant. What we do not know, especially in a seasonally slow quarter, quarter 4 It's always seasonally slow quarter because of furloughs as well. What we are unable to predict is how much of the discretionary gets impacted and how much of Large deal momentum will get neutralized by this. And to that extent, We felt it was only fair that we keep a risk we keep the risk Adjusted to what we believe could be soft in quarter 4.

Speaker 6

Okay. That's very helpful. Thank you. And then I guess just to kind of go even just a little bit deeper into Visibility into 2024 budgeting decisions. I know it's still early and you don't give guidance on 2024 anything yet.

Speaker 6

But just given the current rather choppy macro environment that we're seeing and have seen, can you just speak to sort of the conversations you're having with clients regarding 2024 budgets? Sort of how does that visibility compare with this time last year? And is there more certainty in certain verticals than others? Or just any

Speaker 3

I'll jump in for the number 1, I think we actually I gave a lot of half of the P and L we already disclosed because we're really committing to our 40 to 20 basis Points of margin expansion. And so now the revenue range going forward will be subject to our guidance call in 3 months, but if you what we know today is, as Ravi said, that I think gradually the economic Uncertainty has increased and discretionary spending has softened throughout the last three quarters. So we have seen that trend not stopping yet. And part of our lack of knowledge, if it's stopping in the Q4 or if it's going to turn around early in the year or later in the year, it's really not known to us to be quite honest As well. And clients will be forming their budgets and their IT budget at the same time as we are developing our own budgets.

Speaker 3

So this is kind of always Simultaneous process. What has improved for us is obviously the visibility of the longer term Deals that are now in our portfolio and that they will be contributing and scaling in 2024. So that gives us a little bit of a planning Safety and then we have to just kind of really make assumptions on and you can do that for your own self. It's like are you bullish on the discretionary Spend on economic development next year or are you the same or more bearish? And I think that will then determine the revenue outcome for next year to do so.

Speaker 3

I think that's really what we will go under. We haven't finished that process And, but in January in February, beginning February, we'll commit to that.

Speaker 6

Okay, great. Thank you. I appreciate it.

Operator

Thank you. Our next question comes from the line of Tien Tsin Huang with JPMorgan. Please proceed with your question.

Speaker 3

Hi. Thanks so much. Good afternoon. Just want to drill in maybe for Jan the TCV versus ACV And how to consider that in the short term, the next couple of quarters? I know the book to bill is quite high at 1.4.

Speaker 3

But In terms of translation with this mix shift towards larger deal, how would you guide us there between ACV and TCV? This thank you, Tien Tsin, for that. I gave in my remarks this duration comment. And I think we had in previous calls and historically disclosed that our average duration was roughly around 2 years and now our duration in the Bookings is about 4 years. So it's a meaningful increase and obviously then ACV, the annual Revenue expectations for this is down.

Speaker 3

And that's actually on top, you have also That mix shift. So larger deals need some scaling. So they have the ACV is not completely symmetrical because In the 1st year, you're building up the infrastructure and you're starting transferring assets and do your thing, what you need to do to get ready. So Some of the ACV of the larger deals is delayed and will come in 2024. And at the same time, we have a decline of Deals below $5,000,000 of TCV, which are typically deals that always translate in year to revenue.

Speaker 3

So Those things together are basically a 90% explanation of what you see in our revenue trend, actuals in the last few quarters. And I'm anticipating unless the discretionary spend is coming back roaring that, that won't change. Now so the we're entering the year with all these Moving parts, probably in a position that is not too different from last year in terms of visibility of revenue going forward. So and mysteriously it balances out because some of our larger deals now maturing and scaling, having a little bit better Contribution to next year and then we'll as I said in my prior answer, we'll have our estimate to make on how short term demand is going to be Developing. So the net of it is that Factors within the setup have changed compared to the beginning of 20, 3 versus 2024.

Speaker 3

We are kind of Approximately in a similar position to stock. Okay.

Speaker 2

Just to add to that, what Jan said, Because we didn't have large deals in the previous year, what the slope it had of this year In terms of realizing this year did not happen. What's going to happen for next year though is You're going to have a tail velocity of deals we won this year, which will accrue revenues next year. And that's a change because we have consistently done it from quarter 1, quarter 2, now quarter 3. We have done the percentage of our large deals has gone up and the percentage of new in this large deals has also gone up. So that's a positive change.

Speaker 2

The unknown piece is the discretionary spend.

Speaker 3

Got it. I appreciate all of your comments.

Operator

Thank you. Our next question comes from the line of Keith Bachman with BMO Capital Markets. Please proceed with your question.

Speaker 7

Yes, thanks very much. I wanted to follow-up on that set of comments. And As you think about next year, you've talked a lot about the large deal program ramping and contributing to revenue growth And mentioned that discretionary is still a headwind. Can you give us a sense of proportionality of how much discretionary is of either revenues, It seemed to me as we start to think about growth, that percentage of low duration deals, if you will, or discretionary spend, Is that a level such it would be less of a headwind next year as you anniversary the March quarter when it first impacted Cognizant and many others?

Speaker 2

It's a difficult question to answer Now, on how it's going to be next year. I mean, the swim lane of Large deals we're doing and then that is 30% of bookings. The swing lane of large deals we're doing, Always the savings of those large deals, some of the smarter clients are not necessarily taking it The savings, but they are actually underwriting it for transformation, which means if some of them can trigger the CapEx cycles, Then you're going to see some of that discretionary coming back because the savings you do on productivity We'll allow you to trigger the CapEx cycle. I mean, I spoke about 150 plus AI Preliminary early AI engagements. The reality is if they have to scale up, you need the CapEx.

Speaker 2

The CapEx will either come because our clients have themselves navigated the uncertainty and brought the CapEx covered or They would use some of the savings from the cost cutting and the cost takeout they have done related Technology to leverage it into discretionary. I mean, many of my clients today, I've met 270 of them this year. They're not saying they want to take their ID budgets out. What they're really saying is can you do more for less? And can you actually divert The savings to, divert the savings to the transformation they are looking forward to.

Speaker 2

And they are very, very anxious about the transformation because We are all living in this period of change. The issue is what we what I do not know is whether The economic and the overall environment, which is really a headwind, is that going to change significantly next year? That's Something that's hard to predict now. But if that uncertainty continues, you're obviously not going to see the discretionary spend coming back. But if you see that triggering positively, then you're going to see the savings of this cost takeout initiatives to move into transformation, And that will trigger another cycle of spend, which in turn hopefully will trigger revenue cycles for our clients, will then hopefully create a virtuous positive cycle.

Speaker 2

So it's a tricky one to answer. You need a trigger for the CapEx cycles of discretionery. And all the discretionary spend, as Jan mentioned, these are all deals between $0,000,000 to $10,000,000 They all get realized within the same year Because these are small deals. So it's a very unusual time, a time of uncertainty and a time of change Coming simultaneously. So the cost takeout deals potentially can fund them and that's the point I'm making.

Speaker 2

And if they don't, then there are other triggers of CapEx cycles, which you have to fund them.

Speaker 7

Okay. Jan, I wanted to also Thank you for all the work you've done over the last couple of years. And then direct to question, as you think about the 20 to 40 Basis point range for margin improvement next year. I know you don't want to give metrics with revenue, but just how do you think about the upper end versus the lower end? In other words, is it as simple as discretionary comes back and that That's greater OpEx leverage.

Speaker 7

Is there anything else, puts and takes that we should be thinking about? And particularly, you did mention that the large deal ramps Can and indeed many cases have lower margin profiles. Just any puts and takes that you want us to think about as it relates to the 20 to 40

Speaker 3

Yes. Look, we're entering the year With the NextGen initiative executing well and according to our plans, And we're going to have what were some impact in the Q3, but really not full run rate impact Yet and so we will have a lot of momentum on NextGen next year. So We offered the savings opportunity for 'twenty four to reach for 'twenty five to reach in real estate $100,000,000 savings, and You all have your own assumptions on our headcount reduction program, easy to be calculated. And That's a lot of efficiency that we can book on our side. I anticipate The revenue momentum is obviously the next factor for us that will shift And in that revenue growth factor that determines the scale of our SG and A development and other elements is Probably a big factor.

Speaker 3

And the second one I would give you to you is the style and the execution of our large Deal scaling and all this. With larger deals, there is a little bit of risk factor just by the nature of their scope involved. And If we are executing well and the deals don't develop problems, that will help us to be very solid in our margin expectation. If we run into some problems, maybe we'll need to invest a little bit more costs. So those will be the 2 major factors, Chris, I think that we're going to be considering as we give our margin range and the substantiation of it.

Speaker 2

Yes. So also just to add to what Jan said, The NexGen program really kicked off at the end of quarter 1. We had it back in quarter 2 and quarter 3. It will have a full year impact next year. I mean, the savings will accrue next year.

Speaker 2

And of course, the real estate savings come at the back end as well. So we have No, we have we are going to look at incorporating that into our work As we work out the next year margins. And that's one of the reasons why we reiterated that the 20 basis points to 40 basis points we said Early in this year, we probably have we wanted to reinforce that message that we can get that Margin expansion, which we earlier committed in the year.

Speaker 7

Okay. Many thanks.

Operator

Thank you. Our final question of the night will come from the line of Jamie Friedman with Kahuna, please proceed with your question.

Speaker 8

Hi. Thank you for sneaking me in here. I was wondering if you could share some high level observations And Shruti, about in sourcing trends, is that any different than usual? Do you see acceleration Or deceleration and do you see that as friend or foe?

Speaker 2

That's a great question. I see that as a friend. In fact, I stated that if you carefully observe my initial comments, even before you asked this question, I'd stated that If technology is strategic to our clients and remember technology was a Enabler for our clients, now it is strategic to them because it's deeply embedded into their products. It is integral to the differentiation in the market. Every industry is a tech industry.

Speaker 2

We have to help our clients build their own technology muscle. And to help our clients build their own technology, Marcel, I think Cognizant is probably best suited to do so. Our entrepreneurial spirit, Operating model, our co creation attitude and our co creation culture, we think as companies build their own technology muscles, We will lend a human capital, and I stated this in my remarks, but we would even lend a value chain of human capital, which is not just People to support the transformation, but potentially lending our training infrastructure, our learning infrastructure, our ability to actually Help them build their own captives if they want to or global capability centers. And I think that is sticky because once you do so, You can even lend your automation infrastructure, AI infrastructure and actually take them through that maturity curve. So it's much more sticky than before.

Speaker 2

So I see this as A unique opportunity for Cognizant and we want to double down on this offering.

Speaker 8

And then, you emphasized in your prepared remarks and It did not go unnoticed, the sequential increase in the headcount. And you're one of the few companies, at least, that I'm aware of that's growing their headcount. So my question about that is, are you anticipating, I would assume, increased Utilization and realization from that headcount because the commitment to the headcount is what we think of as a leading indicator. So but where are you planning to deploy those people? And what gives you the confidence to be growing them right now?

Speaker 2

After very, many quarters, we had sequential positive headcount growth. Of course, it is a tiny number, But it is reflective of the momentum of the commercial momentum of large deals and bookings. It is reflective of the needs for the future and is reflective of the needs of the near future. So I'm very, very confident that if we continue on the deal booking momentum, We will have to increase our headcount to fulfill and satisfy those programs. So it's encouraging it's a very encouraging indicator about How well our commercial momentum is shaping up.

Speaker 8

Got it. Thank you.

Operator

Thank you. We have reached the end of our question and answer session, and I would like to turn the floor back over to management for closing comments.

Speaker 1

Great. Thank you all very much for joining. We look forward to catching up next quarter.

Operator

Thank you. This concludes today's Cognizant Technology Solutions Third Quarter 2023 Earnings Conference Call. You may now disconnect your lines. Thank you for your participation.

Powered by Quartr
Earnings Conference Call
Cognizant Technology Solutions Q3 2023
00:00 / 00:00