Cognizant Technology Solutions Q1 2023 Earnings Call Transcript

Quartr
Provided by Quartr
May 3, 2023

There are 8 speakers on the call.

Operator

Ladies and gentlemen, welcome to the Cognizant Technology Solutions First 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 like now to turn the conference over to Mr.

Operator

Tyler Scott, Vice President, Investor of 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 the investor supplement for the company's Q1 of 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 and some of the responses to your questions may contain forward looking statements.

Speaker 1

These statements are subject to the risks and uncertainties as described in the company's earnings release and other filings with the SEC. 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 to 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 turn the call over to Ravi. Please go ahead.

Speaker 2

Thank you, Tyler. Good afternoon, everyone. When I spoke to you early February, I was just 3 weeks into my role. I explained my plan to move rapidly up the learning curve By embarking on a global listening and learning tour with associates, clients and partners, I also mentioned that I would meet with more than 100 clients As many are of our associates as possible. In addition, I outlined 3 interrelated priorities, making Cognizant an employer of choice in its industry Accelerate revenue growth, especially by winning large deals and enhancing our operational discipline.

Speaker 2

I'll comment on progress of each of these areas, but first, I want to cover a few of the quarter's financial and operational highlights. In quarter 1, we delivered revenue of $4,800,000,000 a decline of 0.3% year over year as reported, With a growth of 1.5% in constant currency, above the high end of our guidance range, our adjusted operating margin was 14.6%. We recorded strong quarterly bookings growth of 28% year over year and ended quarter 1 with record trailing 12 months bookings of $25,600,000,000 in the trailing 12 months book to bill of 1.3x. Approximately 30% of our in quarter quarter 1 bookings Large deals, which we define as total contract value above $50,000,000 compared to approximately 20% for all of 2022. We were very pleased with our Q1 bookings performance as well as the build in our pipeline, which includes a strong mix of large new opportunities.

Speaker 2

I'm especially pleased to see the continuing reduction in our attrition with trailing 12 month voluntary attrition for our Technology Services business Declining to 23%, down 3% points sequentially and 7% points Y on Y year on year. While Jan will cover our financial performance at a business segment level given the importance of financial services on our momentum, I want to comment on the state of this business And the emerging opportunities we see in this segment. For starters, we believe our company specific operational challenges and financial services have largely subsided, and we're beginning to stabilize the business. Our client portfolio has shown resilience both in U. S.

Speaker 2

And internationally, but we're also seeing the Back from softer discretionary spending and decision delays by existing and potential clients. In the U. S, our banking clients are generally large institutions, and We have seen an uptick in our deal pipeline. Overall, we have seen early green shoots that we are moving this portfolio in the right direction While navigating the macro dynamics, we are encouraged by leading indicators such as strong Q1 global bookings growth for Financial Services With about 2 dozen of our financial services clients, I came away from these meetings with many new opportunities to pursue related to cost takeout, Vendor consolidation, post merger integration and a new wave of outsourcing and fintechs. Having said that, we still To date, I have met either in person or virtually with C suite executives from more than 100 of our clients representing nearly all of our industry segments And all of our major geographies, several themes have surfaced from these candid conversations.

Speaker 2

We have a strong goodwill with our clients and we continue to recognize our culture of client centricity. They say we are easy to work with, Addentive to nurturing our client relationships and deeply understand their businesses. They like our entrepreneurial approach to developing solutions to their challenges. They also appreciate our humility, our willingness to learn, listen and adapt. I believe the longevity and depth of our relationships have created a lot of accumulated trust.

Speaker 2

By the way, none of our clients I I spoke to mentioned about Cognizant's digital mix. I believe that's because digital and non digital capabilities have converged to the point where the distinction between the two is less Instead, the differentiator many clients have spoken about is how well positioned Cognizant is at the confluence of technology and industry domains. Given that our digital mix is no longer a true measure of the value we are providing to clients, we And competitive challenges that tell me Cognizant has earned the right to challenge their thinking and be a strategic partner Who co create solutions with them and offers insights on improving their operations. Overall, I came away with the sense that many clients are Fans of our company. What also surfaced is that most clients are grappling with largely similar challenges, although with variations by industry.

Speaker 2

The cost basis reflects the higher growth levels seen during the pandemic era, prompting an intensified focus on optimizing cost And boost the efficiency of their commercial and operational teams. In that context, I thought it would be useful to mention a We are partnering with Microsoft to build an integration roadmap between our TriZeta Health products and the cloud for HealthCare. Our shared aim is to give payers and providers easy access to cutting edge technology solutions, streamline Claims management and improved interoperability to deliver better patient and member experiences. In a new win, we are working with Boehringer Ingelheim to speed the development and improve the accuracy of their life saving therapies. We help our clients unify medicinal development processes and data into unified cloud platform and enhance the collaboration across We've been engaged by Volkswagen Group Ireland to reengineer its siloed contact platform into omnichannel customer service landscape that will deliver more personalized agent and customer experiences using Salesforce Cloud and Amazon Connect.

Speaker 2

And last week, we announced a new 5 year agreement to transform and Support the global technology operations of our long term client Nike. We will Help drive customer, employee and partner experiences for NIKE by leveraging hyper automation, AI and processing reengineering. These are just a few examples. In short, our capabilities are in demand as clients navigate an uncertain macroeconomic environment. Let's turn to the company's 3 focus areas of growth enablers and the progress we are beginning to make.

Speaker 2

The first of these is to become an employer of choice. We recognize this is a multiyear undertaking. To take the pulse of employee sentiment, I've been using every communication channel available to get unfiltered feedback from tens of 1,000 of associates to learn what's working well and what needs to improve. As a part of my immersion, I spent 2 weeks in India visiting Half a dozen cities where we have major facilities along with traveling to see associates in the UK, Switzerland, Canada and across the U. S.

Speaker 2

I've been moved by our associates' warmth, enthusiasm and energy, and what I'm hearing from them is very encouraging. In this post pandemic era, We are back to walking the corridors of our clients, mining relationships and building new ones. And we are revitalizing our ability to land and expand within existing clients as we To begin driving the next chapter in Cognizant's nearly 30 year history and are moving forward with renewed confidence about the future. To be an employer of choice, we need to meet the demands of a diverse workforce that spans geographies, Generation and the range of work and life priorities. Here are a few of our approaches.

Speaker 2

We have made career progression easier by expanding our internal job board process and redesigning Promotion process to increase more movement across our organization. We have intensified our focus on continuous upskilling and learning We're expanding our learning library, running internal learning and development campaigns and launching a new leadership training initiative for people at all levels. We've had 3 merit increases in 18 months for the majority of our associates who are in the levels up to Associate Director. And over the past couple of years, we've invested significantly more in compensation. In addition, we are stepping up the efforts to get our associates to return to office because doing We believe helps build and sustain our culture and helps associates build their social capital with colleagues.

Speaker 2

To tap into the creativity of our more than 350,000 associates, we are launching a grassroots innovation movement Because I believe innovative ideas can come from everyone. This program called Blue Bolt encourages and celebrates the Thousands of flashes of inspiration that our associates have every day as they innovate for our clients. Over the coming months, we plan to more than 20,000 additional project leads in our innovation methods and generate over 100,000 ideas for client use, rapid prototyping and the identification of new opportunities. The 2nd focus area I've spoken about is accelerating revenue growth and building commercial momentum, Especially by strengthening our ability to win large deals, our Q1 bookings were a balance of renewals, expansions The new engagements, which we believe will provide revenue opportunities for us later in the year and well into 2024. A strong bookings growth of the quarter, including 4 deals with a total contract value above $100,000,000 To cite one large deal, one recent large deal, Horizon Healthcare Services selected us to manage their claims And counter submissions to the state and enrollment services for their 1,200,000 members.

Speaker 2

In the 7 year renewal agreement, we will bring to bear Advanced Automation Solutions for our TriZetto product suite to help Horizon expedite the claims payment process and ensure accuracy in support of that member services. Our large deal pipeline remains healthy for the next couple of quarters. Large deal bookings that align with our risk are essential to building commercial momentum, but they can take time to ramp up and realize revenue. We are working on strengthening and industrializing delivery to Moving to our 3rd priority, operational excellence. As you may recall from my last call, I said that internal simplification would be a theme we'll carry forward to help achieve the company's full potential.

Speaker 2

Our drive for simplification will include operating with fewer layers to deliver greater agility along with realigning our business to be closer to our And of course, to increase a growth mindset. This endeavor named NextGen He's aimed at building the enterprise of the future by simplifying our business operations, optimizing our corporate functions And realigning the workforce to a post pandemic era of hybrid and redistributed work. The shift will provide an opportunity to rationalize the work Spaces across the world and especially in India's largest cities by redistributing some real estate to smaller cities where we can expand and by modernizing some existing space. We expect the structural shift in our real estate costs to help eliminate 80,000 seats and 11,000,000 square feet in large cities in India. This shift will also enable us to invest in collaboration spaces and smaller cities, while creating structural savings for the future that we can invest in our people and growth opportunities.

Speaker 2

We expect this program to help enable us to deliver margin expansion in the range of 20 to 40 basis points in 2024, while supporting our large deal pipeline. Combined with our efforts to increase utilization, improve delivery efficiency, maintain disciplined pricing And the lower attrition, we believe we have the levers to drive modest margin expansion over the next several years, while we continue to provide periodic updates about our progress in achieving these three priorities. Let's spend a moment on the demand environment and tech trends. We are carefully monitoring what remains an uncertain macroeconomic environment and with its potential for shifts in client priorities. That said, we are optimistic about our long term opportunity within the IT services market.

Speaker 2

The demand for solutions and business outcomes remain solid As technology becomes core to nearly every business. The tech trend on everyone's mind is generative AI With recent breakthroughs offering the potential to fundamentally transform our clients' businesses and increase our own productivity. To that end, we are accelerating our investment in generative AI. Our AI accelerator process uses studio environments to collaborate with clients to identify priority AI use cases and rapidly implement prototype solutions for field testing. We've conducted ideation sessions with over 30 clients and are now working to industrialize solutions to their common challenges.

Speaker 2

We believe generative AI will revolutionize the technology services industry, creating higher rates of productivity And driving greater prominence for software and data engineering expertise. We are using AI to enhance our own creativity and productivity. We are operating pilots that use generative AI to accelerate consulting, design, engineering and operations with the long term goal of doubling the productivity of our associates. With that in mind, last month, we launched Neuro IT Operations, a next generation platform that brings new levels of automation intelligence To applications and infrastructure operations. By applying an AI led automation first approach, we are enabling enterprises to innovate faster And write down cost and risk.

Speaker 2

We believe that adapting new IT operations can actually reduce Operational costs by 25% to 45%, reduce mean time to delivery and mean time to detect by 30% to 50% and reduce FTEs by 15% to 30% compared with the use of traditional approaches. Across every industry, the cloud is today the biggest transformational opportunity, and therefore, our clients need a partner that can Straight cloud in a heterogeneous environment. In response, we just introduced a new cloud platform called Cognizant Skygrade. This multi hybrid cloud and edge management platform applies an industry focused approach designed to help clients Transition to a modern cloud native architecture, develop modern applications that evolve at the pace of business and streamline their cloud management operations. With SkyGrid, we believe we can accelerate migration and modernization programs by shortening transformation time by 20% to 40%, Resulting in faster value realization while reducing ongoing run and governance costs by 15% to 25%.

Speaker 2

To wrap up, I stand behind my initial assessment that Cognizant has the strong foundation in place on which we could accelerate growth. I'm especially optimistic about the strength of our portfolio and partner ecosystem combined with our ability to create value for our clients at the intersection of technology and industry use cases. We recognize that our renewed strength in bookings momentum is helping us replenish softer backlog from the past 9 months, And we believe we can demonstrate improved growth towards the end of this year and in 2024. With that, I'll turn the call over to Jan to provide additional details on quarter and outlook for 2023. Jan, over to you.

Speaker 3

Thank you, Ravi, and good afternoon, everyone. Before I touch on the details of the Q1, I would like to spend a moment on the NextGen program we announced today. During the Q2, we initiated NextGen to simplify our operating model, optimize our corporate functions and realign our office space to reflect our hybrid work environment. We expect to record total estimated next gen costs of $400,000,000 Approximately $350,000,000 in 2023 $50,000,000 in 2024. This consists of $200,000,000 of employee severance and other costs primarily related to non billable and corporate personnel, which we expect to mostly incur in 2023.

Speaker 3

The personnel related actions under this program are expected to impact approximately 3,500 associates or approximately 1% of our total workforce. We expect to realize savings from our NextGen initiative in the back half of this year. The NextGen program also includes $200,000,000 of costs related to the consolidation of office space And approximately $150,000,000 in 2023 $50,000,000 in 2024. We do not anticipate these real estate actions will begin to generate savings until 2024. By 2025, we expect to reduce our annual real estate costs by approximately $100,000,000 versus 2022.

Speaker 3

This reduction is net of investments to expand our real estate footprint in smaller cities, primarily in India in support of our hybrid work strategy. Our full year operating margin outlook includes The anticipated impact of these actions. As Ravi mentioned, we expect this program to help enable us to deliver 20 to 40 basis points of margin expansion in 2024, in addition to funding revenue growth opportunities. This 2024 expectation assumes no further deterioration of the economic environment. Beyond 2024, we are focused on driving structural cost improvements to fund investments to support revenue growth, Our people and modernization of facilities, while driving consistent modest margin expansion.

Speaker 3

Now moving on to the details for the quarter. We were pleased to deliver revenue above the high end of our guidance range, Strong free cash flow and healthy large deal bookings, which has helped us to begin to replenish our backlog following muted bookings growth throughout 2022. 1st quarter revenue was $4,800,000,000 representing a Year over year growth includes approximately 100 basis points of growth from our recent acquisitions. As Ravi mentioned, we were pleased with our bookings performance in the Q1, including the mix shift towards larger deals. We also exited the quarter with a strong pipeline of larger opportunities across industries.

Speaker 3

At the same time, we also saw pressure in smaller contracts, which we believe is a result of a softer discretionary spending Being driven by the macro environment, this environment has a near term impact on our revenue in the second quarter, which I will touch on in my guidance commentary. Moving on to segment results for the Q1, where all growth rates provided will be year over year in constant currency. Within Financial Services, revenue declined 1%. Revenue pressure within our North American portfolio was partially offset by growth in our global growth markets, which was driven by Public Sector and Insurance Clients. In the Q1, bookings growth within Financial Services outpaced the total company We are seeing an improving pipeline of opportunities over the next 12 months.

Speaker 3

While we have begun to see signs of stabilization, We are still rebuilding our backlog as we continue to navigate an uncertain macro environment. We believe this uncertainty has impacted Our sciences revenue grew 4% consistent with last quarter. Growth was driven by increased demand from healthcare payer clients for our integrated software solutions. Products and Resources revenue grew 1%, reflecting inorganic contribution from recently completed acquisitions and continued strength among logistics, utility and Travel and Hospitality customers. This was partially offset by pressure from retail, consumer goods and manufacturing customers, which we believe reflects the economic environment.

Speaker 3

Communications, Media and Technology revenue grew 4%, reflecting slower growth among our largest technology clients and muted growth among communications and media clients. Similar to our other segments, we believe the macroeconomic environment is impacting the pace of decision making and discretionary spending among our Continuing with our year over year growth in constant currency from a geographic perspective in Q1, North America revenue declined 1%. This performance reflected declines within Financial Services and Products and Resources, partially offset by growth in Health Sciences. Our Global Growth Markets or GGM, which includes all revenue outside of North America, grew approximately 7%. Growth was again led by the UK, which grew 14% and included strong double In Q1, both our GAAP and adjusted operating margins were 14.6% as there were no non GAAP adjustments in the quarter.

Speaker 3

On a year over year basis, both GAAP and adjusted operating margin declined by 40 basis points. This primarily reflects gross margin pressure from increased compensation costs, partially offset by tailwinds From the depreciation of the Indian rupee, lower SG and A expenses and the benefit of 2022 pricing actions. Our GAAP tax rate in the quarter was 21.4%. The adjusted tax rate in the quarter was 22.5%. Our effective tax rate included a discrete benefit from a settlement of prior year tax audits.

Speaker 3

Year 1 diluted GAAP EPS was $1.14 And adjusted EPS was $1.11 up 7% and 3% year over year respectively. Now turning to the balance sheet. We ended the quarter with cash and short term investments of $2,500,000,000 or net cash of $1,800,000,000 DSO of 73 days was down one day sequentially and increased one day year over year. Free cash flow in Q1 was $631,000,000 representing approximately 110% of net income. This compares to free cash flow of $186,000,000 in the prior year period, which represented approximately 35% of net income.

Speaker 3

The increase in free cash flows was driven by strong collections. During the quarter, we repurchased 3,200,000 shares for $200,000,000 under our share repurchase program and returned $150,000,000 to shareholders through our regular dividend. We also closed 2 acquisitions in the quarter Mobica, which helps bolster our IoT software engineering capabilities And the Professional and Application Management Services business of OneSource Virtual, a Workday partner. Over the last 6 months, We have deployed approximately $800,000,000 of capital across 4 acquisitions. Before we move to our outlook, I would like Spend a moment to discuss the change in our attrition disclosure.

Speaker 3

As you heard Ravi mention, we're now disclosing voluntary attrition tech services On a trailing 12 month basis, which we believe is most relevant to our business. This new metric includes all employees, except those in our intuitive operations automation practice and replaces our prior disclosure. Now turning to our forward outlook. For the Q2, we expect revenue in the range of $4,830,000,000 to $4,880,000,000 representing a year over year decline of 1.6 percent to minus 0.6 percent or a decline of minus 1% to flat in constant currency. Our guidance assumes Currency will have a negative 60 basis points impact as well as an inorganic contribution of approximately 100 basis points.

Speaker 3

We are also providing initial full year 2023 revenue and operating margin guidance. Our focus for the remainder of the year is Revenue momentum towards the end of this year and as we enter 2024. For the full year, we are guiding revenue in the range of $19,200,000,000 to $19,600,000,000 representing a decline of minus 1.2 percent to growth of Plus 0.8 percent or a decline of minus 1% to growth of plus 1% in constant currency. Inorganic contribution is expected to be approximately 100 basis points. This assumes no major deterioration in the demand environment And our assumption that large deals we have signed and expect to sign in Q2 begin to ramp more meaningfully in the second half of the year.

Speaker 3

Moving on to the adjusted operating margin. We are guiding operating margin to be in the range of 14.2% to 14 Our margin outlook is impacted by several factors. First, we expect the macroeconomic environment will impact pricing, which was a key lever for us in 2022 to help offset the elevated wage inflation. 2nd, we are achieving a faster pace of large deals than we initially anticipated. These larger deals generally have A dilutive impact in the 1st year.

Speaker 3

Finally, as mentioned, the NextGen program is not expected to drive meaningful savings until the back half of this For real estate, we anticipate initial savings in 2024 and the full run rate in 2025. Our operating margin guidance also assumes a sequential decline in Q2 as a result of the merit cycle that took effect from April 1. As a reminder, this is our 2nd merit cycle for the majority of our employees in the last 6 months. We anticipate 2023 interest income of approximately $85,000,000 reflecting the higher interest rate environment And then adjust the tax rate in the range of 24% to 26%. In 2023, we expect to deploy Approximately $800,000,000 on share repurchases, including the activity in Q1.

Speaker 3

This assumes repurchase Activity above our long term capital allocation framework and will reduce our weighted average share count by approximately 2.5% in 2023. Based on the share repurchase activity, we anticipate full year average shares outstanding of approximately $506,000,000 This leads to our full year adjusted earnings per share guidance of 4 point $1.1 to $4.34 which reflects our wider than typical operating margin guidance. Finally, we are targeting free cash flow conversion of approximately 90% of net income, which assumes the negative impact from the changes in the U. S. Tax law that we discussed in February.

Speaker 3

We now estimate the negative year over year impact of 5 $40,000,000 from this change, which is slightly down from our prior estimate. This includes $300,000,000 in deferred payments relating to 2022. With that, we will open the call for your questions.

Operator

Thank you. Our first question comes from Lisa Ellis with Moffett Nathanson, please proceed with your question.

Speaker 4

Terrific. Thanks for taking my question. Good nice uptick here on the bookings side. I just wanted to talk about this dynamic a little bit, maybe understand it a little bit more Is it something that has been a little bit of a struggle with Cognizant over the last few years? You're showing 9%, I think bookings Growth year on year, but that was a book to bill of like 1.3x, which is implies a bit of a disconnect in sort of how bookings translate to revenues.

Speaker 4

Can you just talk a little bit I know you mentioned you're refilling the backlog And you're expected to come in later in the year. Can you just help us a little bit again with how we should think about that dynamic, the translation of bookings into revenue and the timing and maybe what's going on with the backlog or with the underlying base of revenue? Thank you.

Speaker 2

Thank you, Lisa. I'm going to this is Ravi here. I'm going to start off and then ask Jan to add. We recorded very strong bookings, 28% year on year and 12 months trailing Bookings of $25,600,000,000 and you're right book to bill ratios are 1.3x. I think the way to see it is, it has multiple factors associated with it.

Speaker 2

1st and foremost, How much of it is renewable? How much of it is new? How much of it is expansion? While we don't give those numbers out, We had healthy expansion and new business in comparison to the past. We had 4 large deals more than Total contract value of $100,000,000 Just to give you an order of magnitude, last year same quarter, We do not have any large deals.

Speaker 2

Large deals come with a little bit of It comes with a runway where a lot of It is at the end of the cycle or rather at the back of the cycle. Short deals, small deals Come with immediate short fuse demand, which gives you revenue on the short run. Large fuse give you Revenue on the medium to long run, while in the short run, they take a little time to ramp up. So in summary, How this translates to revenue in the short and the medium in the long run is dependent on what percentage of it is large deals, what percentage of it is small deals. You would appreciate small deals are actually a little softer for us because we've we know that the discretionary spend is softening in an economic We are in.

Speaker 2

So the large deals gives us the opportunity to accrue revenues at the back end of this year and the next year While we build the pipe for the future, our pipeline is looking strong as well.

Speaker 3

Yes. Lisa, the 9% trailing 12 months bookings growth is really entirely driven Very strong bookings growth in the quarter. In this quarter, as you know, we had 3 quarters of flat bookings that Contribute to this overall trailing 12 month result. And so the revenue growth in this case We'll be picking up. We expect a model in our revenue guidance, some revenue impact from these larger deals Picking and starting and ramping up in the second quarter in the second half of this fiscal year and then have the full year impact next year.

Speaker 3

So And for the Q2 impacting our guidance is also the anticipation that we see softness In the small scale bookings, for the Q2 in a sense is kind of a transition quarter, I would say, because we have the high bookings growth, Hopefully, continued momentum in bookings as we go through the year, but we do have the short term revenue from the decline of these shorter and smaller deals that are impacted by the economy by discretionary spend. So that's kind of How I think best to understand the relationship between bookings and revenue growth.

Speaker 4

Thank you. And then maybe for my follow-up, Ravi, this one is for you. I know you mentioned you've been out talking to 100 plus clients and Have now been at Cognizant for 3.5 months or so. Can you just articulate when you're talking out there with clients, How you see Cognizant like really uniquely differentiated in the market when you're with what you're hearing back from them, what you're hearing from associates, etcetera?

Speaker 2

Thank you, Lisa. I've met more than 100 clients in my 1st 100

Speaker 3

days across all geographies

Speaker 2

I've traveled extensively to meet them and my associates. I would say, just to keep the high level Observations. I think our clients love the confluence of technology and industry domain, which Cognizant Really comes with Cognizant, if you go back to the history of Cognizant, it was born at a time when there was a tail end of the Y2K boom And it was born to the application outsourcing wave, which was starting off and Cognizant built the capability on a confluence of industry and And Industry and Domain, the confidence is very important now than ever before because we all know that we are living in a golden era of technology where The core of every business in every industry is transitioning to a technology led core or a technology immersed core. So I would say, we have to progressively make sure that the confidence of technology and industry, we actually demonstrate Differentiation in every industry we represent. Our biggest exposure is Healthcare, Life Sciences, Financial Services, Which is where I think we have really doubled down on this conference and we now have to progressively build in every other industry.

Speaker 2

The second piece I would say is client centricity. I think over the years Cognizant's growth has actually come from mining Accounts with the breadth of capability Cognizant brings and of course the entrepreneurial spirit of our teams. These are the three things Which stood out for me. And in fact, some clients actually who have worked with us for very long actually said we are fans of Cognizant. I mentioned that in my Initial remarks, that was that really stuck to me that these are clients who want us to do more with them, who want us to challenge them and who want us to Co create along with them for their technology future, if I may.

Speaker 2

So there can never be a better time for the conference of technology and industry. And I think we are so well positioned for that.

Speaker 4

Thank you.

Operator

Thank you. Our next question comes from Brian Bergin with TD Cowen. Please proceed with your question.

Speaker 5

Hi, good afternoon. Thank you. My first one is a margin and I guess the NextGen program Clarification. And sorry if I missed this, but

Speaker 3

can you give us

Speaker 5

a sense of what the run rate cost reduction or the net savings you expect to achieve by The end of 2024. And I'm trying to understand if the 20 to 40 bps of 24 operating margin is incremental What you would normally had planned for or if that's kind of the total level of operating margin expansion which would align with prior targets?

Speaker 3

Yes, Brian, there's many moving parts here. So let me talk first about the overall program of $400,000,000 of restructuring charges, of which $200,000,000 comes from severance and $200,000,000 comes from real estate, We provided really only an expected run rate savings rate to materialize in 2025 at the full range of $100,000,000 for the real estate component. We offer that savings opportunity because we feel it's hard from the outside to calculate of How restructuring charges in the real estate space translate actually into full run rate savings. So that's kind of we wanted to help you with The impact of the $200,000,000 component for real estate with that, a portion of that a meaningful portion of that will be achieved in 24 and then the full run rate in 25. On the severance, we haven't given you a Net impact or gross impact, number 1, I think you can fairly easily calculate by the number of employees Affected in the severance volume that we anticipate, I'll make an assumption about the cost savings that we would see.

Speaker 3

There are many factors and you see this reflected in a relatively wide range of margin that we give for the year. There's wage inflation, There's an uncertain pricing environment and other things that we will have to manage through. So we haven't given more detail about The $200,000,000 severance charge at this point in time. For 2024, The 20 to 40 basis points of margin expansion would be off the exit rate in 2023, And that would be our current outlook to 2024. It should signal from our point of view our confidence that the full run rate of this program will help us To not only offset large deal pressure that we're going to see for this 1st year business cases of the larger deals Plus the wage inflation, plus other elements for 2024.

Speaker 3

So it's a little unusual that we give that early on the margin, but we felt given that the program is fairly sizable and only a portion is going to be realized In 'twenty three, it will be helpful for you to know that we are confident about return to margin expansion in 'twenty four.

Speaker 2

Just adding one additional thing out here. I think these are 2 structural shifts in our cost as well. Real estate costs in a hybrid environment as well as the structural shift in our Personal costs, which is a part of our SG and A, I think is an important part of this program. It's a structural shift.

Speaker 3

Yes. We should mention that we did, I think, in our script that we are focusing on non billable and corporate functions. So These are intended to actually lower our SG and A rate basically.

Speaker 5

Okay. Okay. I appreciate that. That's helpful. And then a follow-up, Ravi, on the large deal front, I guess, maybe the sales force.

Speaker 5

Can you talk about what you're doing specifically in these large deals pursuits and maybe Your initial assessment of the sales force and the incentive structure, I'm curious what you may have put in place here early on in 1Q to give you some quick wins?

Speaker 2

Yes. So we are very excited about the large deal momentum. This is initial momentum based on the bookings this I would say there are 2 swim lanes to this. 1 is a swim lane on transformational deals, which I think In some ways now a little slowdown with the current economics environment. There is a second swim lane on cost takeout.

Speaker 2

Cost takeout specifically in industries which went through a higher growth rate in the last few years, but are starting to go back to the post pre pandemic growth rates. They're starting to see that There is significant opportunity to take out cost and they're using vendor consolidation or cost take out as a way to construct a large deal. I see more of them now. I would say both the swim lanes are equally important as the economy takes a turn, you're going to see more transformational digital work Coming the other way. So I would really say both these are the 2 big categories of large deals.

Speaker 2

And the industries where We see more of it are the ones where there was a swing of growth during the upward trajectory of growth in the last few years where that Growth has started to taper down. The timing wise also the labor market is a little softened. So this is a good time for all our clients to start to get efficiencies and cost takeout and use a partner like Cognizant to support it. So we see more of them now than before. And of course, it's also reflective that our clients have the confidence to for us to execute for those deals.

Speaker 5

Thank you very much.

Operator

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

Speaker 1

Hey, Ashwin, you made me on mute.

Speaker 6

Hey, sorry, didn't recognize it was my name being called, sorry. Ravi, hi, Ian. Good to hear from you. Clearly, you guys Both been very busy. I appreciate the well thought out commentary.

Speaker 6

I guess, I wanted to ask first about the cadence that you expect. Obviously, you're given Q2 outlook. Is there more of a ratable improvement from that rate to get to the full year? Or is it more of a I don't want to call it a 4Q hockey stick, but is it a sharper improvement to the positive For 4Q? And then the same similar question on margins, if you can talk about cadence.

Speaker 3

Yes. I mean, you see our revenue guidance for the Q2 is largely in line with our revenue guidance in the Q1. And so we do not anticipate really material contribution of the large deals that we signed until the 3rd Q4 of this year. So we do anticipate revenue growth acceleration Throughout the fiscal year, throughout the quarters. And I think we're giving you a fair revenue guidance for the 2nd quarter.

Speaker 3

We did still see basically pressure on some discretionary projects and smaller deal, as I mentioned In my comments before, so I think the revenue guidance is kind of where we really solidly think we're going to be at. The margin guidance is a very important question, Ashwin. And so keep in mind, we do For the vast majority have implemented in April, a merit increase and the 2nd quarter will therefore be different from our historic profile of margin that we have shown in the past year. So Our Q2, I think warrants a good look at what happens when we implement that merit increase, which happened historically in our Q4. And so Think of it as a normal merit increase and the margin pressure that you will get from it.

Speaker 3

And that's going to be Some material impact for us in the Q2. That's why I'm mentioning it. And if you do the math of Our comparable merit increase in the 4th quarter and exclude the one time components of the 4th quarter that we had, You'll see that in the Q4, we recorded about 100 basis points impact of that merit increase on our margins. And fair to assume that Things wouldn't be that different in the Q2. Maybe actually, probably slightly a little bit more pressure because the economy is changing a little bit.

Speaker 3

But That's kind of the framework. That's why I want to point that out. So and then the people action Our next gen program, we're going to start to execute in the second quarter. But given of how we're going to be executing, of course, the Q3 and the 4th it will be reflecting the impact of a big portion of that program or a good portion of that program.

Speaker 2

And Ashwin, if you just jog your memory on this, we actually did 1 in October, a merit cycle and we're doing one more in April. So these are 2 merit cycles, in fact, 3 merit cycles in 18 months. It's good for other associates. It starts to reflect on Our attrition number is starting to drop and you've already seen that it's an investment for the future, but it equally has pressure on our margins. Understood.

Speaker 6

I guess the first part of that question was on revenue cadence, if you could address that. But then I also want to ask you, your headcount did go down sequentially. When do you expect that to Stabilize and start to grow, I guess, in anticipation of revenue growth in the future. And what part do you think increased automation, applying AI to yourselves Might play as you think of headcount in the future?

Speaker 2

Ashwin, that's a great question actually. One of the things, As I mentioned, my priority is to get commercial momentum, large deals, Reduce our attrition and be an employer of choice. The third piece I spoke about is simplification of our operations. The NextGen program is an important program to delay our organization and to simplify Our operations equally one of the things we want to bring a huge cadence on, I think in the last 12 months or so, we had some We had a very good initiative around pricing in the market, and that's a way to actually keep your margins intact. One of the focus areas for me moving forward is increased utilization, higher offshoring, Better pyramid ratios, better leverage of Gen Z program and The 4th is what you just mentioned, which is embrace of automation in everything we do.

Speaker 2

In fact, just Few weeks ago, I launched a platform called Neuro IT Operations, where we're going to go relentless on applying automation to ourselves, Both on technology as well as IT operations and of course on the process side. So We do think this is going to be a little bit of a structural shift in the way we see our operating model, Where we look at an uplift of margins not just through pricing, but also through operational efficiencies and the leverage of automation. Automation is a moving scale. When everybody moves on that scale, you then start to share those benefits with your clients. When you start to share those benefits with your clients, you have to re innovate so that you can actually be ahead of the curve and keep it for yourself.

Speaker 2

So it's kind of a cycle you have to keep working on. And then when everybody when you start to share it with your clients, when there is a new baseline, We baseline it with more innovation. So I would say we are now we've got into that rhythm. So we are very excited about how it how we could be competitive to our deals, which we are starting to see and how we could also on the downstream price deals So it's an important shift in the way we are seeing Operating model and it's an evolving scale because of the fact that technology in that space is evolving so fast, Including the leverage of generative AI to increase developer productivity, which is the new thing we are working on.

Speaker 6

Thank you very much.

Operator

Thank you. Our next question comes from Shrinder Pheede with Jefferies. Please proceed with your question.

Speaker 7

Thank you. Following up on the last question, Ravi, can you maybe talk about the level of productivity gains in terms of potentially automation and the level of disruption here? And what I'm getting to here is, is there the potential for a step function change? And if there's a step function change, does that impact the revenue model as you look over the long term, right? I assume you won't be able to generate the same level of revenues for a given level of service.

Speaker 2

It's an interesting question because it all depends on how Marc, you want to leverage the productivity you generate out of these tools and instrumentation and platforms Into your deals and use that to win more and share it with your clients. And how much you could actually Constantly innovate beyond the time when you start to win the deals to when you start to execute the deals. So it's a Very difficult one because it's a moving scale because nobody spoke about generative AI in 2022. Everybody is speaking about it Because just the scale at which it's come to disrupt various businesses in the world, including ours, right? So I would say it's a hard one to put a quantifiable impact on revenue and on margins.

Speaker 2

It is a moving scale. We have to be constantly ahead of the curve. And again, constantly ahead of the curve not to execute programs, but also We're going to win business because these are the same productivity baselines we actually take into our proposals. So sometimes we wonder as the baselines Constantly change whether it will translate that back to your bottom line or it will translate that back to better win ratio. So you have to Keep that balance so that you have growth and equally you are able to generate that growth in a profitable way by not The traditional levers of higher utilization, higher offshoring, better role mix, but also Using technology as a lever to do this.

Speaker 2

So I know I've given you a high level answer, but it's very hard to simulate and put a revenue model Attached to it, because it is just such a fast moving curve. I actually think we are well equipped to Capitalize on the advances in the space and we're well equipped to generate that value for our clients We're well equipped to actually evolve our business model, which is potentially going to go from people to a people plus machines model, if I may, or a people plus AI amplified human model, which I've been very fascinated about.

Speaker 7

Thank you. That's it for me.

Operator

Thank you. Our next question comes from Bryan Keane with Deutsche Bank. Please proceed with your question.

Speaker 1

Yes. Hi. I just had a question on the overall IT services environment. Just thinking in your conversations you had with the 100 or so clients, Ravi, are people expecting the environment To stay similar in their IT spending budgets? Or do you think people will put further pressure on budgets

Speaker 2

Yes, it's a great question actually. I will kind of Pivot this in a little different direction. If you are working on traditional technologies or classical technologies, as I call it, Which is enabling the business. The pressure on IT budgets is going to be very high because a lot of it is cost driven. If you are building a CRM system, if you are building an HR system, a supply chain system.

Speaker 2

I think the pressure of IT budgets with the economics uncertainty is going to be Very it's going to be tight. That's how I see it. If you are leveraging technology to disrupt the core of our Business, as an example, if you're doing the connected car initiative of an automotive company, I don't think budgets will come on the way because it's a disruption of the business model. Equally, the capability you need is going to be Deep as well, which means you have to build different swim lanes in your operating model so that you could cater to classical technologies on one side, but equally cater to Deep expertise needed for disrupting the core of businesses. This is a streamline which did not exist before Because most businesses enable the businesses using technology now, technology has emerged into businesses, which I think We'll have more flexibility on budgets because the paranoia about the core changing You could become irrelevant if you don't make the change and therefore you allocate more for securing your future as a business.

Speaker 2

Some industries are doing it more paranoid because there is more change in the core products and services and some are actually Not as worried about this issue. I would say, depending on where you are, this You would find IT budgets to be under stress or you're going to find IT budgets not to be under stress. The second piece I would say, We all have to think about is our universe is not as much just tech spend of enterprises. Our universe Is operations spend of enterprises because technology is so deeply immersed into operations. So if you put that lens in, Operations, which have to be automated for better experience for lower cost, for higher for high touch services, You could potentially immerse in technology, outsource and immerse in technology for companies like Cognizant to benefit out of So if I see that as the universe, that's a very different universe.

Speaker 2

In fact, just to give you a case in point, there are companies which have accumulated cost Equivalent to the growth rate during the pandemic and when they go back to the pre pandemic era, those growth rates start to papered down, they have To take their operations cost down, so they could either do it by automating it or they could do it by outsourcing and offshoring it. So It can have a benefit there. So I would say these are 3 different things to look at. Even today, there is Consolidation of providers, cost takeout, which is actually winning in the terms as I call it, where customers don't spend more, But there is a swap of the portfolio between one provider to another provider, which means one wins and one loses. So it's kind of If I just look at straight ID spend in classical technologies, you will have a different answer for Oh, you would have a different answer.

Speaker 2

And of course, if you're consolidating providers, it's a win for 1 and loss for somebody else.

Speaker 3

Okay, great. Yes, thanks for the color.

Operator

Thank you. At this time, I would like to turn Floor back over to management for closing comments.

Speaker 1

Great. Thank you everyone for joining. We look forward to catching up with you next quarter.

Operator

This concludes today's Cognizant Technology Solutions First Quarter 2023 Earnings Conference Call. You may

Powered by Quartr
Earnings Conference Call
Cognizant Technology Solutions Q1 2023
00:00 / 00:00