Cognizant Technology Solutions Corporation

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 speaker's remarks, there will be a question and answer session. If you would like to ask a question at that time, please press star 1 on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. And you may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Thank you. I would now like to turn the conference over to Mr. Tyler Scott, Vice President, Investor Relations. Please go ahead, sir.

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 third quarter 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. These statements are subject to the risk 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 now turn the call over to Ravi. Please go ahead.

Thank you, Tyler. Good afternoon, everyone. Today, I would like to cover three topics. Our third quarter results, the demand environment, and a brief update on our strategic priorities. We are pleased with the company's continued progress in the third quarter, during which clients remained cautious amid economic uncertainty and discretionary spend was under pressure. Q3 revenue came in at 4.9 billion within our guidance range. 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% 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 26.9 billion, up 16% year-over-year and a strong book-to-bill of 1.4x. We have sustained our large deal momentum through Q3. Approximately 30% of our in-quarter Q3 bookings were large deals, and three of these deals exceeded $100 million 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. 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 strengthen the portfolio over the long run. While Leon will cover our performance at a business segment level, I want to offer a quick word about financial services. We continue to reposition our financial services segment while responding to an increasingly challenged demand environment. 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 initiatives to 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. For example, during the quarter, we expanded our relationship with Lineage, a global leader in temperature-controlled logistics, to help build an industry-leading operating platform and establish a plan to support their operations through automation and infrastructure management. We also established a new multi-year relationship with Swedish firm Intrum. We expect to provide end-to-end support 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 two-day discovery summit last month for about 130 of our North America clients, our first large-scale client gathering in more than four 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. We also ran live use cases at Cognizant's NeuroAI platform, showing generative AI working alongside legacy data and machine learning models to rapidly create end-to-end AI use cases to tackle client KPIs. As mentioned last quarter, we expect to invest approximately $1 billion in our generative AI capabilities over the next three 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 gen AI. We've also invested in AI partnerships and experimental infrastructure to support early client engagements. 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 a recently refined strategy, which is aimed at strengthening Cognizant's differentiation to help drive growth. Our strategy is focused on three imperatives. 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 expertise across our value chain and select industries. We are developing more enterprise-scale platforms designed for industry and operational use cases. Partnerships have a major role to play here. We are focused on expanding our partner ecosystem across a range of technology providers. Among them, hyperscalers, cloud providers, enterprise software companies, digital software enterprises, and emerging startups. We believe this partner ecosystem will enable us to enhance our integrated offering by combining third-party products with our service solutions, helping to deliver enterprise-wide digital transformation. We believe this strategy as a full-stack provider opens new and significant managed services opportunities. Second, 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 technology transformations. 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. A 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. These deals have a potential to bring cognizant into the heart of clients' business landscape, 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 two, more than 35,000 of our employees have generated 75,000 ideas. We have already implemented about 14,000 of these ideas, nearly 6,000 of which are client-facing. A strengthened ability to co-innovate with clients is especially valuable as they grapple with understanding and applying generative AI. During the quarter, we launched Telco Assurance 360, a cloud-based AI-powered solution 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 administration of health and human services programs across the U.S. 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 our TriZero platform 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 architecture, cloud infrastructure, and core business applications. Today, we are running more than 150 plus early client engagements that incorporate the use of generative AI. 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 three long-term strategic objectives, starting with becoming an employer of choice in our industry. I see Carbizent as a human capital company first, and a technology company second. 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 four. It's also worth noting that in quarter three, 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. With that in mind, we announced a groundbreaking training initiative yesterday called Cognizant's Cognizant's Synapse initiative, our job training endeavor, is aimed at empowering more than one million 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. As I mentioned earlier, we are pleased to see our continuing large deals momentum, which is underpinned by the work we are doing to improve 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 third 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. Differentiation in the tech services industry happens at the client side and the project level, making relationships and strong execution key. That's why I've invested so much time in meeting with over 270 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. 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 efficiency-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. Taking a longer view with 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 intertwined domestic and international risks. What can become a transformative change is being driven primarily by new general-purpose technologies with immense power such as generative AI, which I believe could become as ubiquitous and consequential for business and society as the Internet did three 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 their peers. I believe Cognizant is 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, and we are excited that he will be joining us in December. 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.

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 three 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 Japan 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, Devjatin, and the rest of the leadership team to ensure a smooth transition. With that, let's turn to our third quarter results. 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 range that I will touch on later. We were also pleased to deliver another quarter of solid bookings growth, which continued to be driven by larger, longer duration engagements. Moving on to the details of the quarter. Third quarter revenue was $4.9 billion, an increase of 0.2% sequentially. 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. This dynamic has negatively impacted our near-term revenue but we believe will put us in a better position to accelerate revenue growth in the future when discretionary spending improves. Moving on to segment results for the third quarter, where all growth rates discussed will be in year-over-year and 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 third-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 fourth quarter. 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 pear 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. 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 and constant currency 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. 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 third-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 million of costs related to our NextGen program. 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 two 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%. 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 $2.4 billion, or net cash of $1.7 billion. ESO of 77 days increased two days sequentially and three days year over year. Free cash flow in Q3 was $755 million, which brings year-to-date free cash flow to approximately $1.4 billion. For the full year, we continue to expect free cash flow to represent approximately 90% of net income. During the quarter, we repurchased 4 million shares for $300 million under our share repurchase program and returned $147 million to shareholders through our regular dividend. Year to date, we have repurchased approximately 11 million shares for about $700 million. At quarter end, we had $2.1 billion remaining under our share repurchase authorization. Turning to our forward outlook. For the fourth quarter, we expect revenue in the range of $4.69 to $4.82 billion, 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 contribution of approximately 100 basis points. 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 19.3 to 19.4 billion dollars, which is down approximately 0.7% 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 $19.2 to $19.6 billion, or negative 1% to plus 1% growth in constant currency. We still expect inorganic contribution to be approximately 100 basis points. Our next-gen 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 million in total charges versus $350 million previously. with $200 million this year versus $250 million previously. The reduction is a result of lower real estate costs as we now expect to incur about $100 million related to the net consolidation of office space in 2023 versus $150 million previously. 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 in 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 million and an adjusted tax rate of approximately 34% versus the range of 23 to 24 previously provided. In addition, we now expect to deploy approximately $1 billion on share repurchases in 2023 versus our prior expectations of approximately $800 million, which assumes an additional $300 million of share repurchases in the fourth quarter. In total, we expect to return approximately $1.6 billion to shareholders through share repurchases and dividends in 2023. Our guidance for shares outstanding is unchanged at approximately $506 million. This leads to our full year adjusted earnings per share guidance of $4.39 to $4.42 versus $4.25 and $4.48 previously, reflecting our updated expectations for revenue and adjusted operating margin. With that, we will open the call for your questions.

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. Confirmation tone will indicate that your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. In the interest of time, we ask that you limit yourself to one question and to one follow-up. One moment, please, while we poll for questions.

Thank you.

Our first question comes from the line of Brian Bergen with TD Cowen. Please proceed with your question.

Hi. Good afternoon. Thank you. So, 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 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 really backlog behavior and pipeline, can you share any thoughts or guardrails for 2024 growth now as well?

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

Yeah, so, Brian, you know, I've been saying this for the last two 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 two swim lanes. 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, You know, remember, one of the things I spoke on in my initial remarks is this is a period of uncertainty and change coming together. So clients are navigating the two. There is change, significant change ahead of us, and clients are wondering who funds the CapEx cycle. So the ability to take costs 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 first 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. 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 will 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. 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 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.

Okay, understood. My follow-up here, just on the resale piece of the third-party products, I think you mentioned 120 bps in the quarter. How does that compare to maybe the average over the last four to six quarters? And are you assuming resale amounts in the forward outlook?

Yeah, so, Brian, you know, I had spoken about a strategy of large deals in all swim lanes, you know, all the way from – productivity to people take over to software led to efficiency led and I've spoken about it that our participation is going to be in all of them. Now sometimes what happens in these situations is you have upstream software coming in 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 so you know we've had 60 basis points before in the year then we have added in this quarter but what you really have to look at is the timing of these deals now in in quarter two we announced a strategic partnership with ServiceNow for a billion dollars a joint partnership, and we have an offering which actually has a bundle of software, reusable assets, and services attached to it. And it is a managed services model, and that's the opportunity we are pursuing. And as the 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 takeover, sometimes there is asset takeover, sometimes there is productivity upfront and effort upfront, sometimes you have transition upfront and you have services on the downstream. So it's hard to pick which quarter you're gonna see this, but the nature of large deals gives you that flow, if I may, in terms of how they get constructed quarter to quarter.

Okay, I appreciate the detail. Thank you.

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

Thank you. Hi, Ravi. Hi, Jan. Hi. I would say, I guess before I start, Jan, I guess this is going to be your last earnings call. Thank you for all the work and effort over the years. You know, the question is, Ravi, since you've come to Cognizant, you've 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 competitive 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, say, low single digits and mid single digits.

Yeah, I'll give a little bit of an answer, but I think Ravi will be adding much more color to this discussion. The overall position that we have with our clients, I think, has really meaningfully improved over the last three or four 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. 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 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. 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 a high focus on client relationships and feel we should be ready for that to do so. Ravi?

Yeah. So thank you, Jan. I think very well said. So Ashwin, thank you for the question. You're absolutely right. 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 three 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 to the classical levers, which you apply in managed services and cost takeout kind of deals. 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 know, you could, in some ways, use the strength of current deal momentum to support the historic discretionary muscle of the company. Now, I think Jan raised an important point, which I think is very, very important. You know, we ran the net promoter score survey this year, and we have historic high scores. And there are three or four 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. Our client satisfaction scores are on an all-time high. Our customers are engaging with us much more over a variety of swim lanes, which means when the discretionary comes back, each of these swim lanes is going to contribute back to that, you know, back to the strength of those relationships. So, you know, in fact, there's one thing which really registered with me on the Net Promoter Score survey, which is about a customer 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 a customer starts spending it. 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 significantly much lower risk. turnover of employees. And these would actually rub off on the discretionary as it comes back.

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?

Yeah, 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 actually needed in this quarter on, for example, investments into larger deals with maybe initially lower margins and we didn't need those investments. So I think this view that we have about very carefully layering our large deal portfolio and supporting it with disciplined approach on non-billable and administrative cost controls is playing out and I think we're entering that year of next year with that confidence that that balance is 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 have very meaningfully actually renewals of historic deals that have very meaningfully improved our gross margin profile in the renegotiation. So in the net profile, the impact has been actually more muted. And that may not continue all into the future, but for now it has been a very balanced outcome, I would say.

So Ashwin, you know, the first thing we just changed is we are participating on deals across the swim lanes that you 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, 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 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 where 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. Now we are participating and winning them, so the confidence has been really high.

Thank you both.

Thank you.

Our next question comes from the line of Jason Kupferberg with Bank of America. Please proceed with your question.

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 couple of months, whether that's changes in win rates, ramp times, or softness, whether that's a particular service offering, vertical, geography, anything like that that may be driving the additional cautious stance?

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 four is always a 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 our large deal momentum we'll get neutralized by this. And to that extent, we felt it was only fair that we keep the risk adjusted to what we believe could be solved in quarter four.

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, 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, you know, is there more certainty in certain verticals than others? Or just any clarity there would be very appreciated.

Yeah, I'll jump in for number one. I think we actually kind of gave a lot of, half of the P&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 three 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 fourth quarter or if it's going to turn around early in the year or later in the year is really not known to us, to be quite honest, as well. clients will be forming their budgets and their IT budgets at the same time as we are developing our own budgets. So this is kind of always a 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 24. 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 and 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. I think that's really what we will go under. We haven't finished that process. But in January, in February, beginning of February, we'll commit to that.

Okay, great. Thank you. I appreciate it.

Thank you.

Our next question comes from the line of Tianxing Huang with JP Morgan. Please proceed with your question.

Thanks so much. Good afternoon. Just want to drill in maybe for you on 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, but in terms of translation with this mix shift towards larger deal, how would you guide us there between ACV and TCV?

Thank you, Tinjin, 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 two years, and now our duration in the bookings is about three years. So it's a meaningful increase and obviously then ACV, the annual revenue expectations for this is down. 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 first year you're building up the infrastructure and you start transferring assets and do your thing what you need to do to get ready. some of the ACV of the larger deals is delayed and will come in 24. And at the same time, we have a decline of deals below $5 million of TCV, which are typically deals that always translate in-year to revenue. 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. 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. Mysteriously, it balances out because some of our larger deals now are 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 23, but in 24 we are kind of approximately in a similar position to start.

Just to add to that, what Jan said, because we didn't have large deals in the previous year, 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 one, quarter two, now quarter three. 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. The question, the unknown piece is the discretionary spend.

Got it. I appreciate all of your comments.

Thank you.

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

Yeah, 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 bookings any kind of metric um and how that's changed today from what it is beginning year because it seemed to me as we start to think about growth that percentage of low duration deals if you will or discretionary spend is at a level such it would be less of a headwind next year as you anniversary the march quarter when it's when it first impacted Cognizant and many others?

It's a, you know, it's a difficult question to answer now on how it's going to be next year. I mean, you know, the swim lane of large deals we're doing, and that is 30% of cookings, the swim lane of large deals we're doing always the savings of those large deals, some of the smarter clients are not necessarily taking it to 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 will allow you to trigger the capex cycles. I spoke about 150 plus AI, you know, preliminary early AI engagements. The reality is if they have to scale up, you need the CapEx. The CapEx will either come because our clients have themselves navigated the uncertainty and got 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 down. What they're really saying is, can you do more for less? And can you actually divert the savings to the transformation they're looking forward to? And they're very, very anxious about the transformation because we're all living in this period of change. The issue is, 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, which will then hopefully create a virtuous positive cycle. So it's a tricky one to answer. You need a trigger for the capex cycles of discretionary. And all the discretionary spend, as Jan mentioned, these are all deals between $0 to $10 million. They all get realized within the same year because these are small deals. You know, it's a very unusual time, you know, 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. And if they don't, then there are other triggers of capex cycles which have to fund them.

Okay, 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 associated with revenue, but just, you know, how do you think about the upper end versus the lower end? In other words, is it as simple as, you know, discretionary comes back and that has greater OpEx leverage? 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 basis points range?

Yeah. Look, we're entering the year with the next gen initiative executing well and according to our plans. And we're going to have some impact in the third quarter but really not full run rate impact yet. And so we will have a lot of momentum on next gen next year. And so we offered the savings opportunity for 24 to reach, for 25 to reach in real estate, $100 million 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&A development and other elements is kind of probably a big factor. 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. And if we run into some problems, maybe we'll need to invest a little bit more cost. So those will be the two major factors, I think, that we're going to be considering as we give our margin range and the substation of it. Yeah.

So, you know, also just to add to what Jan said, you know, the next-gen program really kicked off at the end of quarter one. We had impact in quarter two, in quarter three. It'll have a full year impact next year. I mean, the savings will accrue next year. And of course, the real estate savings come at the back end as well. So we have... Now we are going to look at incorporating that into our workings as we work out the next year margins. And that's one of the reasons why we reiterated that the 20 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.

Okay. Many thanks.

Thank you.

Our final question of the night will come from the line of Jamie Friedman with Susquehanna. Please proceed with your question.

Hi. Thank you for sticking me in here. I was wondering if you could share some high-level observations for the about insourcing trends. Is that any different than usual? Do you see acceleration or deceleration, and do you see that as friend or foe?

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 had 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 we have to help our clients build their own technology muscle and to help our clients build their own technology muscle i think Cognizant is probably best suited to do so. Our entrepreneurial spirit, our flexible operating model, our co-creation attitude and our co-creation culture. We think as companies build their own technology muscle, 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 the people to support the transformation, but potentially lending a training infrastructure, a learning infrastructure, our ability to actually help them build their own cap devs 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. So I see this as a unique opportunity for Cognizant, and we want to double down on this offering.

And then you emphasized in your prepared remarks and comments 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 of But where do you plan to deploy those people, and what gives you the confidence to be growing them right now?

You know, after very many quarters, we had sequential positive headcount growth. Of course, it is a tiny number, but it is reflective 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 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 a very encouraging indicator about how well our commercial momentum is shaping up.

Got it. Thank you.

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.

Great.

Thank you all very much for joining.

We look forward to catching up next quarter.

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.