Cognizant Technology Solutions Corporation (NASDAQ:CTSH) Q2 2023 Earnings Call Transcript

Cognizant Technology Solutions Corporation (NASDAQ:CTSH) Q2 2023 Earnings Call Transcript August 2, 2023

Cognizant Technology Solutions Corporation beats earnings expectations. Reported EPS is $1.14, expectations were $0.97.

Operator: Greetings, and welcome to the Cognizant Second Quarter 2023 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Tyler Scott, the Vice President of Investor Relations. Please go ahead.

Tyler Scott: 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 second 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 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.

Ravi Kumar: Thank you, Tyler. Good afternoon, everyone. I would like to discuss four topics with you today. Our second quarter results, the demand environment of comprehensive commitment to generative AI and an update on our long-term priorities. We made continued progress during the quarter in what remains an uncertain global macroeconomic environment. Q2 came in at $4.9 billion at the high end of our guidance range. We were pleased to return to sequential revenue growth of more than 1%. Year-over-year Q2 revenue showed a modest decline of 40 basis points or essentially flat in constant currency. Our adjusted operating margin was 14.2% and adjusted EPS was $1.10. We recorded another quarter of strong bookings growth 17% year-over-year ending quarter two with record trailing 12-months bookings of $26.4 billion.

A book-to-bill of 1.4x approximately 30% of our in quarter Q2 bookings were large deals and five of this deals exceeded $100 million each. Our bookings continue to be a balance mix of renewables, extensions and new opportunities. The leadership team and I remain intensely focused on a talent. So I am glad to see the continued reduction in our iteration with trailing 12-months voluntary attrition for our tech services business declining to 19.9% down 3 percentage points sequentially and 11 percentage points year-over-year. While Jan will cover our performance at a business segment level, I want to offer a quick word about financial services. Our quarterly year-over-year revenue decline in the segment reflects the soft market and continuing weakness in discretionary spending.

In response, we are transitioning more existing work in the sector towards managed services as many clients remain focused on driving cost takeout, vendor consolidation and productivity initiatives. We also stepping up our engagement with fintech companies which we believe offer a great opportunity for digital transformation. And we are strengthening our capabilities with a goal of capturing discretionary spending on transformation work when it returns. For example, we continue to support the modernization of S&P Global’s Configure Prize Quote System to enable end-to-end digitization in what we believe is the world’s largest CPQ implementation on Salesforce. And we are collaborating with Max, Life Insurance to launch an innovation and development center in Chennai to help accelerate the digital transformation efforts.

With a flexible fine-centric operating model, we can assist clients across industry sectors, takeout costs, consolidate their vendors and achieve both technology and operational efficiencies which provide opportunities for large deals. We can also help them develop digital platforms to deliver richer and more personalized experiences to their customers. What’s more, we can engineer technology into their products and services. As an example, we recently extended a partnership with Gilead Sciences. This agreement includes the renewable and expansion of Cognizant services for a total expected value of $800 million over the next five years. We’ll manage Gilead’s global idea infrastructure while leading digital transformation initiatives designed to enhance their overall client experience and enable faster time to market for the products.

We will apply the power of GenAI and Intelligent Automation to help improve Gilead’s customer service experience and assist in driving greater manufacturing efficiencies. To support clients’ transformation leads, we’ve established a distinctive position across industry using a platform-centric approach designed to speed clients’ consumption of technology. You’ve seen the emphasis we’ve given to this platform approach. For example, Cognizant, TriZetto and healthcare are shared investigator platform in life sciences, asset performance excellence in smart manufacturing and Car-to-Cloud in automotive. Last quarter, we launched two new platforms with applications across industries, new royalty operations, which enables AI-led autonomous operations and Cognizant Sky-grade designed to help clients maximize the full potential of cloud.

Turning to AI in quarter two, we expanded our platform portfolio further with Cognizant Neuro AI. It’s designed to speed the adoption of generative AI and harness its value in a flexible, secure, scalable and responsible way. With Neuro AI, we are helping clients advance from identifying company-specific use cases to operationalizing AI. I should point out that generative AI is a natural evolution of a work-crossed cognitive AI enterprise applications in data analytics services. To extract value from GenAI, the data must be curated, trained, modernized and made production ready. You also need a deep understanding of clients’ data estate, data architectures, data usage patterns, and business applications of the data. Our current approach to leverage third-party foundational models and enhance them with our platforms and IP and then fine tune the models for clients.

Today we have more than 100 active client engagements in various stages with the focus on cognitive and generative AI, as well as hundreds more projects using AI services within the context of delivery. We’re designing a generative AI offerings for industry-specific solutions, cross-industry use cases in productivity, enablement, under themes like transforming code processes, improving the customer and employee experience, product innovations, software and coding, and knowledge management to name a few. For example, one of the world’s largest healthcare product companies, we are helping to speed up the research process by deploying GenAI to author scientific content. We developed a workbench that uses GPT models to summarize and generate content from unstructured and structured data, such as laboratory information management systems with the aim of automating the generation of regulatory content.

For a top-20 property and casualty insurer, we have helped frame its GenAI strategy and conduct real-world tests based on company data. For example, we built a GenAI-based digital virtual assistant that analyzed large loss complex claims submissions. By referencing the insurer’s claim data, the virtual assistant was able to guide a human claims handler to gather nearly 100% of missing claims information. This simple application is expected to produce millions of dollars in savings through improved operational efficiency and reduced claim costs. In addition, we signed a new multi-year agreement with Nuance Communications, a Microsoft company, to help scale the resources for Nuance’s Dragon ambient experience operations. This solution is at the forefront of conversational AI and ambient clinical intelligence.

Let’s turn to the essential role partners play in delivering our AI capabilities. We expanded our alliance with Google Cloud to help enterprise clients create, migrate, and modernize their AI journeys, and offer clients innovative industry solutions founded on the tenet of responsible AI. Our investments in developing GenAI capabilities include launching the Cognizant Google Cloud AI University, a program designed to train 25,000 Cognizant professionals on Google Cloud AI technologies. We’ll offer this program to our clients as well. And earlier today, we announced that as a part of our expanded partnership with Google, we’ll be building on Google Cloud’s Generative AI technology with Cognizant’s AI domain expertise to create a healthcare large language model.

This LLM is designed to simplify and improve the accuracy of complex healthcare administrative tasks and strengthen business outcomes for healthcare organizations. We’ve also expanded our relationship with Microsoft to deliver industry solutions and enable AI-led transformation. This includes expanding the focus of our Microsoft Center of Excellence in AI and other next-gen technologies to drive competencies across architecture, technology leadership, value delivery tools, and enablement. Cognizant and ServiceNow have announced a strategic partnership to accelerate the adoption of AI-driven automation across industries. Our industry expertise and solutions integrated with ServiceNow’s intelligent platform for end-to-end digital transformation will bring to market offerings that are designed to solve complex problems, automate operations, and enhance employee as well as end-customer experiences through the use of AI.

Now a quick update on our three long-term performance objectives, becoming an employer of choice in our industry, accelerating revenue growth, and enhancing operational discipline. Let’s start with the employer of choice. During our Q4 call, I talked about how tightly linked the client and the employee experience are, giving Cognizant the opportunity to create self-reinforcing cycles. Highly engaged talent with a passion for clients and a growth mindset attract the best clients. These clients, in turn, attract more of the best people, keeping the flywheel turning faster. Now, two quarters later, we are seeing the early benefits of this interdependent relationship between employees and clients. Our trailing 12-month voluntary attrition has been trending downwards for the last four quarters.

And our just-completed annual people engagement survey showed meaningfully improved engagement results. Among the many questions the survey poses to associates, we saw multipoint increases in three areas strongly correlated to engagement. Would you recommend Cognizant as a great place to work? Are you excited about Cognizant’s future? And do you plan to be working at Cognizant two years from now? On the client side, data from our project-level client feedback process through the first half of this year shows solid improvement over the previous period scores as well as our best net promoter score since launching this program in 2021. I see us making real progress on creating a self-reinforcing cycle. From day one, my commitment to our associates has been to cultivate a diverse organization that reflects the world in which we operate.

Our top priority has been to increase a diverse talent including at leadership levels. I’m delighted to say that in the past couple of months we have appointed 7 women to fill strategic roles at the Senior Vice President level. We are resolved to help all our associates bring their best selves to work and that means focusing on all aspects of their Cognizant experience. For example, we develop talent early through educational partnerships and apprenticeships. We invest heavily in upskilling and reskilling current employees through our award-winning leadership and development ecosystem. We also employ innovative trained to hire initiatives such as the Cognizant’s Skills Accelerators aimed at people seeking to kickstart a technology career in the U.S. and the Cognizant internship program for technology professionals looking to restart their careers.

Our next priority is to accelerate revenue growth which is the absolute focus of the entire management team. We are differentiating Cognizant and large-deal opportunities by scaling our capabilities for cost take-out and optimization and focusing more on managed services. And we continue to see a strong pipeline of opportunities of the cost and efficiency side. Given the groundswell of interest in generative AI, the number of projects we have underway focused on cognitive and generative AI, we see this technology generating a new wave of opportunities for us. Accordingly we expect to invest approximately $1 billion in our generative AI capabilities over the next three years. Our third long-term priority is to enhance our operational discipline.

We are working to fortify a day-to-day business execution and optimize cost of delivery by driving higher productivity powered by advances in tooling platforms and automation technologies and by improving their operational labor in areas like billable utilization. Our NextGen program which we announced last quarter is on track. We are making progress on removing structural costs as we continue to simplify our operating model and reline our office space to the future of hybrid work. Or our last call, I talked about a plan to redistribute some of our development centers from India’s largest cities to smaller cities. I’m pleased to announce the first phase of this shift with the planned opening of two new centers, one in Bhubaneswar and the other in Indore India, which offer great talent pools.

Keep in mind the next generation next-generation program, over rights, overriding aim is to generate savings to invest in our people and our growth. Yan will provide additional details in his remarks on the next-gen program. In closing, I’m now seven months into my tenure as a CEO. I’ve met with more than 200 clients, dozens of our partners and through in-person and virtual town halls with most of our workforce. I’ve also made a point to continuously soliciting ideas and perspectives from our top thousand leaders on strategic topics of importance to our future. Further, a company-wide grassroots innovation movement launched earlier this year, Blue Bolt, has led to such a surge of fresh ideas with more than 32,000 generated so far that it’s now serving as a company’s innovation engine.

I’m convinced Cognizant path to winning in the market place, runs through fully embracing our heritage and DNA. We are leaning into our heritage at the intersection of industry and technology, a flexible client-centric operating model and a distributed delivery network that bring together global and local capabilities. All-in-all, we’ve been making good progress, but to recognize how much more work lies ahead, continuing to build on our growth imperatives as the goal on which everyone in the company is focused. I especially want to express my heartfelt gratitude to all our associates for the extraordinary work they do each day. Before I turn the call to Jan, I want to comment on his plans for the future. Jan let me and the board knows his intention to retire from Cognizant early next year.

Jan has been a wonderful business partner to me and over the past three years he’s played an instrumental role in designing and executing a strategic financial and operation operating plan while developing superb talent with our finance organization. As we begin the search for the company’s next CFO, I’m grateful for Jan’s willingness to work closely with his eventual successor to ensure his smooth transition. With that, I turn the call over to him to provide additional details on the quarter. Thank you.

Jan Siegmund: Thank you, Ravi, for the kind words. I’m proud of what we have accomplished over the last three years, including our work together over the last seven months. I’m looking forward to continuing our partnership in the months ahead while the search for my successor is underway. Until then, it’s business as usual, so with that let’s turn out to our second quarter results. We delivered second quarter revenue at the high end of our guidance range and adjusted operating margins above expectations. We were pleased to deliver another strong quarter of bookings growth, driven by larger and longer duration deals. Our pipeline for larger bookings also remains strong and is up meaningfully year-over-year. Additionally, our NextGen program is on track and yielding early savings through our efforts to structurally reduce our cost base and fund investments for growth.

Moving on to the details of the quarter. Second quarter revenue was $4.9 billion, representing an increase of over 1% sequentially and a decline of 40 basis points year-over-year, or roughly flat in constant currency. Year-over-year growth includes approximately 130 basis points of contribution from our recent acquisitions. Bookings growth in the quarter was again driven by a mixed shift towards larger deals, which had in turn led to longer average duration of our bookings. We are pleased with our bookings performance in the quarter and are focused on building momentum in the quarters ahead. Consistent with the first quarter, we have continued to experience softness in smaller, shorter duration contracts, which we attribute to weaker discretionary spending.

The translation of bookings to revenue growth is impacted by this change in deal mix. As duration has increased, the conversion to revenue will be longer, but helps to improve our forward visibility. Moving on to segments result for the second quarter, where all growth rates provided will be year-over-year in constant currency. Within financial services, revenues declined 5%, which reflects a softer overall demand environment and weak discretionary spending. As we navigate this environment, we have continued to strengthen our leadership team and sharpen our client engagement. While our pipeline for work related to cost takeout and productivity-led initiatives remains healthy and meaningfully higher than prior year period, we expect the uncertainties of the macro environment to continue to impact the pace of client spending over the next several quarters.

Health sciences revenue grew 2%. Growth was again driven by strong demand from healthcare clients for our integrated software solutions, which increased mid-teens year-over-year. While the life sciences was down year-over-year and impacted by softer discretionary spending, we experienced strong sequential growth driven by increased volumes with existing customers. Products and resources revenue grew 4%, reflecting the benefit from recently completed acquisitions, ramp of recent wins, and demand from automotive and travel and hospitality clients. This was partially offset by softer discretionary spending across industries. Communications, media, and technology revenue declined 40 basis points, reflecting softness among both technology and our communications and media clients.

We expect growth to improve in Q3 as recent new bookings have already begun to ramp. Continuing with year-over-year revenue growth in constant currency, from a geographic perspective in Q2, North America revenue declined 2%, reflecting softness within our financial services and CMT portfolio. This was partially offset by growth in health sciences and products and resources. Our global growth markets, or GGM, which includes all revenue outside North America, grew approximately 5%. Growth was led by Europe, which grew 6%, and included strong growth within CMT and products and resources, particularly within automotive. Now moving on to margins. During the quarter, we incurred approximately $117 million cost related to our previously announced NextGen program.

This negatively impacted our GAAP operating margin by approximately 240 basis points. Excluding this impact, adjusted operating margin was 14.2%. Operating margin included the negative impact from an increase in compensation cost, primarily the result of our two merit cycles since October 2022. This has impacted both gross margin and SG&A. This was partially offset by tailwinds from the depreciation of the Indian rupee and higher utilization. It also included an approximate 60 basis points benefit from an insurance recovery related to our previously disclosed 2020 cyber incident. Our GAAP tax rate in the quarter was 21.1%. Adjusted tax rate in the quarter was 21.7%. Our effective tax rate included a discrete benefit from a settlement related to U.S. state income taxes.

Q2 diluted GAAP EPS was $0.91 and adjusted EPS was $1.10. Now turning to the balance sheet. We ended the quarter with cash and short-term investments of $2.1 billion or a net cash of $1.4 billion. DSO of 75 days increased two days sequentially and one day year-over-year. Free-cash flow in Q2 was a negative $32 million which reflects the previously disclosed impact from the change in the U.S. law that we discussed earlier this year. This change negatively impacted Q2 free cash flow by approximately $420 million which included tax payments of approximately $300 million related to 2022. This impact was largely in line with our expectations and we continue to expect free cash flow to represent approximately 90% of net income this year. During the quarter we’ve repurchased about three million shares for $200 million under our share repurchase program and returned $148 million to shareholders through our regular dividend.

Year-to-date we have repurchased approximately six million shares for about $400 million. At quarter end we had $2.4 billion remaining under our share repurchase authorization. Turning to our forward outlook. For the third quarter we expect revenue in the range of $4.9 billion to $4.94 billion representing a year-over-year increase of 0.6% to 1.6% or a decline of 50 basis points to an increase of 50 basis points in current constant currency. Our guidance assumes currency will have a positive impact of a 110 basis points as well as an inorganic contribution of approximately 100 basis points. For the full year we are reiterating our constant currency revenue growth guidance. Our range is slightly wider than our historical practice reflecting a heightened level of uncertainty and the recent pace of client decision-making.

For 2023 we expect revenue of $19.2 billion to $19.6 billion representing a decline of 0.9% to a growth of 1.1% or a decline of 1% to growth of 1% in constant currency. Inorganic contribution is still expected to be approximately 100 basis points. The midpoint of our guidance suggests a softer fourth quarter relative to historic norms as we anticipate softer demand and more volatile discretionary spending patterns driven by macroeconomic uncertainty to continue throughout the end of the year. As I mentioned earlier, the next-gen program is on track and our assumptions for cost savings are unchanged. However we now expect to incur $350 million in total charges versus $400 million previously. This reflects our assumption for lower employee separation cost as a result of voluntary attrition trend.

We now expect to incur approximately $250 million of next-gen cost in 2023 including approximately $100 million relating to employee severance and an unchanged $150 million related to net consolidation of office space. Moving on to adjusted operating margin, our guidance is unchanged at 14.2% to 14.7%. Our margin outlook is impacted by several factors but primarily the negative impact from recent merit cycles. It also reflects our assumption for NextGen savings and growth investments including the dilutive early impact associates with large deals. We anticipate 2023 interest income of approximately $115 million versus $85 million previously reflecting the higher interest rate environment. Adjusted tax rate is expected to be in the range of 23% to 24% versus 24% to 26% percent previously due to several discrete items in the first half of the year.

In 2023 we continue to expect to return approximately $1.4 billion to shareholders through share repurchases and our regular quarterly dividend. We continue to expect full year average shares outstanding of approximately $506 million. This leads to our full year adjusted earnings per share guidance of $4.25 to $4.48 versus $4.11 to $4.34 previously. With that we will open the call for your questions.

Q&A Session

Operator: Thank you. [Operator Instructions] Your first question comes from Ashwin Shirvaikar with Citi. Please go ahead.

Ashwin Shirvaikar: Thank you and good execution in the quarter. I think my first question is with regards to the bookings. If you can provide maybe a little bit more color with regards to the nature of bookings, the nature of discussions with clients, and maybe even any CCD versus ATV balance that you can maybe talk about. Because I think the bigger issue here is not the bookings but the conversion.

Ravi Kumar: Thank you, Ashwin. This is Ravi here. We had another good quarter of bookings growth, 17% Y&Y. We are excited about — I’ve spoken about this before — there are two swim lanes on large deals. One is related to transformation. One is related to efficiencies, productivity, cost takeout. I think it’s fair to say that at this point of time the deals we are seeing in the market are over-indexed to efficiency, cost takeout, consolidation kind of deals. We are excited about the fact that we are starting to win them and translate that into revenues for the future. You would understand that these deals come with a gestation period which is longer than the smaller deals or the transformational deals because of the nature of them.

We had five deals more than $100 million TCV in the bookings. Two of them were renewals. One of them had renewals plus expansion. Two of them are net new. So a very healthy mix if I may, of our bookings. The interesting part of doing large deals is you build the rhythm so that even if the period is long enough, as you keep building the rhythm, it will start to contribute to the next year and the next year. I wish I had a big pipe the year before so that it would have contributed this year. So that’s how you see it. You have to create that rhythm. Financial services, of course, is less on small deals. Financial services and, for that matter, most of the sectors are muted on discretionary spend on small deals. So that’s the color of what we are seeing.

We continue to be excited about our ability to win, our ability to also build the organizational infrastructure to execute them, including the productivity gains which we have baked into those deals as we factor them to win and execute. Jan, do you want to add anything?

Jan Siegmund: Yes. So Ashwin to your question of translating all those bookings into revenue, I think intuitively you had already your finger on one of the components of the characteristics of our bookings this quarter, and that’s basically, on average, the duration of the deals that we signed up in the last year has very meaningfully lengthened, basically. So we have been signing up longer-term deals, on average, with a higher deal value. We actually saw an absolute decline on smaller deals with lower deals below $5 million in our pipeline and that’s softness and discretionary spending and smaller type of deals was just offset by the really excellent performance that we had on the larger deal volume and so that led to the 17% overall booking scope.

But with respect to translating into revenue, the actual contribution of this book in volume just to give you an example for the rest of year revenue is actually lower than it was in the comparable quarter. So we really have built a pipeline for longer type of revenue streams in the future, which obviously gives us good comfort into the quality of revenue stream going forward, but it also explains why and we’re not seeing immediate uptake on our revenues as these bookings will take time to translate into revenue.

Ashwin Shirvaikar: Thank you, that’s very useful. This second question on margins, pretty solid performance here and the question with regards to why you might not increase the full year range. I think Jan you answered part of that question in your prepared remarks when you said that there’s a ramp cost. I just want to make sure are there other things investments you’re making, from a R&D perspective perhaps into GenAI capabilities or things like that, investment payment, are there non-deal related factors also included in your decision to think the margin is unchanged.

Jan Siegmund: Yes, I think the starting point for the market discussion is for the rest of the year, the one thing that’s different compared to prior period is that we won’t have an October at fourth quarter merit cycle in our in this year, because as you know, we move forward our merit cycle into April. So that’s going to be important as you build a quarterly model to consider. Secondly, I use this moment maybe to talk a little bit about the progress we have been making on our next year in the initiative, we have been recording a severance cost in the quarter as well as cost related to the restructuring or real estate portfolio and we’re going to start seeing increased impact of the NextGen action relative to our people in the third and fourth quarter, which gives us basically the room to offset some of the pressures that we’re seeing, namely some of expected pressure on the large deal rollout and letting those larger deals season in.

And I think the general expectation of a given a higher uncertainty in our business environment that will create, I think, it could create some kind of unspecified yet to be seen pressures in our portfolio. We do have seen a number of clients, kind of reacting to their own economic pressure it’s reaching out to us. So we do see an economic environment in which they is pressure and so I think it turns out that I think NextGen is well-time to help us through this, but not it would be too early to celebrate basically a false success of that but we’re kind of really moving along in the execution of that program gets a bit of confidence to just reaffirm basically that operating marginal outlook.

Ashwin Shirvaikar: Makes sense. Thank you both.

Operator: Next question, Lisa Ellis with MoffettNathanson. Please go ahead.

Lisa Ellis: Hi, good afternoon. Thanks for taking my question. Oh, follow up. Maybe first on the GenAI thread and Ravi you commented extensively on what at Cognizant you’re doing on GenAI externally with partners and to help clients transform their businesses. Can you comment maybe a little bit more detail on how you are deploying GenAI internally at Cognizant and how you see it over time you know being able to transform your business operations and maybe give you more competitive edge relative to peers. Thank you.

Ravi Kumar: Thank you for that question. I did extensively speak about it because it is in the middle of everything we do in the company today. I see this as three; the GenAI embrace is going to be in three parts. The first part is how do we apply to our business to run our business, which is like eating our own dog food. The second is how do we make sure that we build our operating model, how would by GenAI? How do we make the average developer productivity increase multi-fold? How do we make sure that we build the platform to the instrumentation, the technology we need it. I also call it the ability to arbitrage on technology. I mean over the last 40 or 50 years tech services companies did labour arbitrage and capability arbitrage I would say this is our time to actually do an arbitrage and technology.

The more the more instrumentation we create, the more we can make our model efficient enough with productivity gains. The question is how much of the productivity has to be shared with our clients so that we stay competitive to win as well as keep a part of it for us for ourselves. So I’m not as concerned about a smart developer, I’m concerned about an average developer how do I lift the productivity so that the productivity of the organization goes up? So that’s my second part of GenAI. We have extensively worked on building those platforms and we also started to partner with a big tech companies. I would say our ability to train in fact we made an announcement with Google to train 25,000 people. We made great progress on it. We ran an initiative with Microsoft on GenAI and the co-pilot initiative.

Today along with the earnings we also timed a large language model in partnership with Google. I think that’s a step up. I mean, in general way I can, we could use the curation of data, the ability to use, use the model to contextualize to a business. I would say that’s the last mile on generative AI. But leveraging our healthcare expertise, leveraging the asset we have and healthcare, the install base we have in healthcare. We potentially thought it’s a good board move to actually build a large language model with Google. Now the third part of the mix, before I go to the third part, equally we are starting to think about how do we actually build cognitive skills in the company, which are different to the past. I mean, if generative AI is going to co-exist with humans in tech services, the reality is you read a very different cognitive diversity.

We could potentially need people who don’t have a stem background because the people who have a stem background engineer those platforms, so the people who come with a cognitive diversity of say human sciences can actually apply generative AI to a client’s landscapes. Now coming to the third part of a generative AI story is, how do we actually embrace with our clients. I’ve actually spoken about a couple of examples in my earnings script, which is starting with a client at financial services. We have one on one on health care. All of those need front-end consultative skills to start with and back in platforms to support it. So our clients, we almost have 100 plus early engagements either on a proof of concept or on prototype model, where we are experimenting on how do we embrace generative AI with our clients.

These 100 early engagements in different areas of the most I would say is in customer service. And the most I would say is related to efficiency, productivity and better experience. So I’m excited about all of what we’ve done. We’ve also completed $1 billion in the next three years to continue our investments in the space. And we want to stay ahead of the curve and be that cutting edge partner which our clients are looking for.

Lisa Ellis: Terrific. Thank you. And then maybe for my question, my follow-up. I guess thinking about it as I’m being sad about Jan’s departure. But Ravi, maybe back on you know that you’ve been at Cognizant I guess coming up on a year or so. How are you thinking about kind of shaping the senior executive team at Cognizant? Are there some other kind of senior leaders you would point to that you’re bringing in and that you’re thinking about finding a replacement for Jan sort of what’s the profile and of folks that you’re looking at and bringing in given the priority you highlighted about making the Cognizant a top place an employer of choice. Thank you.

Ravi Kumar: Thank you for that question. Jan is going to be with us until we identify a new CFO, and we’ll have some overlap period to it, and he’s been kind enough to partner with me in the last 7 months. I’ve not spent a year yet, but in the last 7 months but I’m very hopeful as we finish the transition, I will continue to have his support for the next few quarters. On leadership, per se, we have a very healthy bench. As I put my structure in place, I am excited about promoting and progressing people inside the company and giving them the opportunities. In fact, we have a sizable workforce which has spent more than 7 to 8 years at Cognizant. And I’m actually leading on to build that leadership from inside. We’ve also — I’m excited about Cognizant employees coming back to Cognizant.

I mean, some of the leadership which left us in the last few years, which we believe are worthwhile and they call Cognizant their home, we have got them back. I have one leader who’s come back to do my Industry Solutions Group. I have one leader who has come back to run my infrastructure sales. I’m also excited about other external hires we’ve done. We’ve hired a leader for our telecom business. So the excitement of being a part of this journey allows me to straddle between the three, look for people inside the company who can be on that. And I think we have a very good bench of people who have been in the company for a long time, and I’m excited about grooming them to the future leadership. The second is bringing some of the people who want to come back, and we believe that they will add significant value to our future, and of course, the external hiring we could do.

In fact, I hired a senior leader for running my partner, organization. So we have made some good progress on putting a leadership team to support us for the future.

Operator: Next question, Bryan Bergin with TD Cowen. Please go ahead.

Bryan Bergin: Hi, good afternoon. Thank you. So Ravi, wanted to follow up with a demand question here. Just did you get a sense of any real changes in demand KPIs over the past three months? Or would you say it’s been largely consistent as it relates to the level of macro and spending uncertainty that you have been conveying here over the course of 2023? And I guess based on these current client conversations, are you getting any sense of how long you anticipate discretionary spending to remain under pressure?

Ravi Kumar: That’s a great question, actually. I mean, the demand profile has certainly been very volatile. I mean, if you are capturing opportunities related to discretionary spend, capturing opportunities related to future transformation of enterprise landscapes, it’s either been uncertain or it’s been kind of, in some places, it has fallen off. And that’s one of the reasons why Jan mentioned that smaller deals have — we have lesser volume of smaller deals and which is true for what the market situation is. Of course, Financial Services is the most impacted but we do see that in other sectors as well. I equally believe it also opens up an opportunity in places to consolidate. It opens up an opportunity to proactively go to our clients who are paranoid about the costs and give them a value proposition which appeals to them where their total cost — the total cost of ownership goes down but we’ve been in the process.

It’s a win-win value proposition. So I’m seeing more of those deals and I’m doubling down on those deals, and that is allowing me to keep the large deal pipeline in good health. And it is an opportunity for us to even proactively go and bid for some of the business. I mean, one of the deals we announced is the Gilead Sciences deal, which is an existing customer. And we not only renewed the contract but we actually got an expansion on it. The key point there is in the past, those consolidation initiatives were run by a smaller productivity attached to technology and a bigger productivity attached to the efficiency of running your labor model, including offshoring, including a better pyramid, including a better roll ratio. I think we have a unique opportunity to switch that into a technology arbitrage which I spoke about, which is using technology to get better productivity and then sharing the benefits to your clients.

And that can happen more with consolidation and I think we are trying to seize those opportunities. So I see like these two swim lanes, one which has kind of shrunk and another which is continuing to be in good shape. The idea is to double down on the one which is continuing to have traction so that you could set off against what you’re losing on the other side. But discretionary spend is pretty weak. That is something I should highlight.

Bryan Bergin: Okay, okay. Understood. Appreciate all the color. And then just shifting to the workforce. So understanding headcount down quarter-over-quarter a bit more, I think, in the second quarter, but you do have NextGen flowing through there. Just thinking forward in the second half, is it fair to assume this workforce level remains relatively flat to down, just given the optimization in workforce and utilization?

Ravi Kumar: The way I see it is there is opportunity for us to increase billable utilization, and I think there is some more headroom for me to do that. And as I continue to do that, we all want to hit end of a runway on increased utilization. That’s when you will see a flip on how you need more headcount to increase billable headcount. So I’ve said this in my last quarter as well that there was a cushion for us to increase utilization, billable utilization, that also contributed to our margin trajectory a bit. And I think we have some more headroom to increase our operational efficiency to run our business so that we can then get to a point where we then start to increase our net headcount. What also is important is we’ve also had a good trend of lower attrition.

In fact, we ended up with 19.9% on a trailing 12 months, which is 3 percentage points lower than last quarter and almost 11 percentage points lower than Y-on-Y. And as we can keep that down, it will also help us to keep the headcount up. And then as we get to the other end of the NextGen cycle, it will kind of help. So I think we have some headroom for operational efficiency to conduct more billable work before we start to see headcount increase.

Bryan Bergin: Understood. Thank you.

Operator: Next question, Rayna Kumar with UBS. Please go ahead.

Unidentified Analyst: Hi, good afternoon. My name is [indiscernible] I’m dialing in for Rayna. I had a question around generative AI. So the benefits of GenAI have been widely discussed but we haven’t heard as much about the potential risks. Given that GenAI can potentially improve the internal productivity, do you think there’s a risk to the top line over the medium term from like short contract lengths or pricing pressures?

Ravi Kumar: This industry has always had productivity tools. If you go back to the last 20, 25 years, productivity tools have been a way to differentiate, and it has very nicely got baked into our estimation model and then subsequently our execution model. And in addition to labor arbitrage, those productivity tools were the reason why our clients actually came to us because we had capability, we had — we, of course, had capacity and we had productivity tooling to help them to deliver projects. I would say the advent of automation technologies in the last, I would believe, 5 years or so, including robotic process automation has been a continual embedment into our services. And I want to highlight that the universe we operate in is no longer tech spend of enterprises.

The universe we operate in is operations spend of enterprises because technology is deeply embedded into operations. So these tools — embedding these tools has been — the industry as well as Cognizant has been very habituated to it. I mean, the ones who do it more are the ones who benefit out of it, and they then bake it into the estimation models. And the estimation models then allow you to stay more competitive than your peers to win business. And then as you win the business, you then keep working on engineering more so that you stay ahead of the curve. GenAI in a way has been a bigger inflection point. It’s not different in that continuum but it’s a much bigger inflection point. It is a complete game changer. So my belief is, and at least on behalf of Cognizant, I would say, we want to embrace that as much, to make it an opportunity for us for the future.

If you don’t embrace it, it’s going to become a threat for you. If you embrace it and create that technology arbitrage I spoke about, it will allow us to get our clients to partner with us, even get our clients to partner with us at points where our — at points where they believe that they could in-source. They would potentially outsource because they see us as a unique way to bring productivity to them. So I’m excited about the fact that this is going to be an opportunity. And it’s a tectonic shift in the way our operating model will be.

Operator: Thank you. Next question, Jamie Friedman with SIG. Please go ahead.

James Friedman: Hi, I’m just curious as to — in terms of the environment for the second half, what do you see as the factors that could put you, say, towards the higher or lower end of the guidance, with furloughs contemplated potentially for the fourth quarter?

Jan Siegmund: Yes. We — well, we try to give guidance that reflects at the midpoint our true expectations of what we achieve. So that’s really our core belief. And the elements that we are watching carefully in the next couple of quarters are the scaling of the implementation of a couple of our large contracts that we signed. Those are complex deals that need to be rolled out in partnership with our clients. And that can be just the practicalities of a complex project can give delays or can give you positive news. So that’s something that I’m very carefully watching. And certainly, there could be a theoretical path that some of these projects scale a little faster than we anticipated and that would give us some upside. But also in the quarter, we have observed this economic uncertainty hitting us, and you always get also some unanticipated bad news that happens.

Certain deals get either canceled or scaled down or less visible, smaller deals just dissipate into nothing. So the general economic environment and the climate of our clients, and Ravi just gave you the assessment, we kind of feel that, that pressure will continue in the second two quarters on discretionary spend. That puts the pressure on it. And so in a sense, it’s really a balanced outlook that I have. We are lucky that we are able to add the revenue stream of large deals into our revenue mix compared to our competitors in our market. We didn’t have that last year, and so this is a truly incremental opportunity for us. But as everybody, we are facing also with a downward pressure in the rest of our portfolio. So I think the outlook that I gave is a fair and balanced view of the expectations that we have.

James Friedman: Okay, thank you for that. And for my follow-up. Jan, that’s a great answer. But just wondering could you double click on the assumptions by vertical? I realize you don’t guide by vertical but, are at a higher level, any of these contemplated to be above or below the corporate average?

Jan Siegmund: Yes. I think the one that what we’re trying to signal in my comments also is that we feel that for the next couple of quarters, we’re going to continue to see the pressure in Financial Services performing below our own. I hope, basically, but then the reality of a sector that has shown weakness really, I think, across in our industry. I don’t anticipate that to change. And there’s some strength, as you saw in the quarter and now have strength on a relative basis in Healthcare. And that reflects our strong market position that we have with our clients in Healthcare. So those would be the two big factors. Those trends are relatively consistent, I think, with what we have seen in the first two quarters of the year.

James Friedman: Thank you.

Operator: Next question, Tien-Tsin Huang with JPMorgan. Please go ahead.

Tien-Tsin Huang: Hi, thanks so much for taking my questions. And Jan, congrats on the retirement news. I want to ask on the booking success, especially on the larger deals you have been talking about here. What changes are working? Is there a way to rank that for us because we get a lot of questions on pricing, of course? Where does pricing rank amongst all the factors with you winning on the larger deal side? And is there any impact here on gross margins for the second half to consider?

Jan Siegmund: I think from my perspective, pricing is definitely a very important factor. All these deals are — or the vast, vast majority of these deals is competitive and you just have to be in the range of the expectations and meet the clients. And that is kind of table fixed. The commitment that the company brings to the table as we now compete for these large deals, from Ravi at the top to the entire team, from our markets to our integrated service lines is really different and I think has made a difference in winning the deals. Our clients have seen the commitment that we are making and the importance that we are giving to their specific deals just by the, I think, pure exposure and access to our teams and then obviously, the strength of our solutions that we have brought to the table.

So it’s that whole package that plays into it. I would say these deals that you have seen here in the quarter and really starting in the year, a little bit stronger focused on traditional deals, focusing on cost takeout and some on consolidation, are more classic deals, bread-and-butter type deals, large in nature but that have made the portfolio of those wins. Maybe Ravi, you add a little?

Ravi Kumar: Yes. So large deals come with a very different rhythm, right? We have made sure that we have an outreach now to our — to a chance, I mean, partners, hyperscalers, deal advisories and a whole bunch of players in the mix. The second is our ability to build institutional infrastructure because a lot of deals don’t just need the heavy lifting upstream. They need the heavy lifting downstream as well. So that you price them to win but you deliver them to margins. Our ability to put all of that together, I think the company had it before. I have kind of assembled it together and then we have strengthened it further. And our entrepreneurial spirit to go and tell our clients some provocative opportunities, which could create a win-win situation for our clients and us, and therefore, create value for the process, has helped us to create a large deal mindset or a growth mindset.

And I’m very confident that, that’s now a part of the muscle of the company. So as we continue to invest on deal infrastructure into the market, as well as the mindset to be provocative with your clients and support that bold vision by building downstream infrastructure, organizational infrastructure including the tooling on new age AI-led productivity, that’s very important. The deals could be traditional but the levers you press could be relatively new. I mean, the amount of automation infrastructure, the amount of AI infrastructure you could use to actually create straight-through processing and operations kind of work and create higher productivity run, maintain as well as build businesses for our clients, I think, is — it’s a new lever.

And I think we — I’m confident that we are ahead of the curve and therefore, we are competitive in the market to win these deals.

Tien-Tsin Huang: Perfect. Thank you both on the thoughts.

Operator: We’ve come to the end of the Q&A session. I would like to turn the call over to management for closing remarks.

Tyler Scott: Great. Thank you very much, Stacey, and thank you all for joining us tonight. We look forward to catching up with you on our next earnings call. Talk to you soon.

Operator: This concludes today’s teleconference. You may disconnect your lines at this time and thank you for your participation.