Cognizant Technology Solutions Q4 2022 Earnings Call Transcript

Quartr
Provided by Quartr
February 2, 2023

There are 8 speakers on the call.

Operator

And gentlemen, welcome to the Cognizant Technology Solutions 4th Quarter 2022 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. Thank you. I would now like to turn the conference over to Mr.

Operator

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

Speaker 1

Thank you, operator, and good afternoon, everyone. By now, you should have received a copy of the earnings release And investor supplement for the company's Q4 and full year 2022 results. If you have not, copies are available on our website, cognizant.com. The speakers we have on today's call are Steve Broleader, Chair of Cognizant's Board of Directors Ravi Kumar, Chief Executive Officer and Jan Siegmund, Chief Financial Officer. Before we begin, I would like to remind you that some of the comments made on today's call and some of the responses to your questions May contain forward looking statements.

Speaker 1

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

Speaker 2

Thank you, Tyler, and thank you all for joining us today. Given the recent news, I wanted to join the call for this quarter to introduce myself and explain the changes we've recently announced. For those of you that don't know me, I'm Steve Roeder, and I joined the Board as an independent Director in March of 2022. Last month, I became Chair of Cognizant's Board of Directors. I previously spent 35 years at Accenture, Where I served as Group Chief Executive of Health and Public Services, Chief Executive of North America and Chief Operating Officer.

Speaker 2

Today, I'd like to briefly discuss our recent CEO transition and the Board changes announced this afternoon supporting our ongoing Board refreshment I also want to explain why we're excited for Cognizant's next chapter. Ravi will then introduce himself And share his thoughts before Jan discusses our 4th quarter results in detail. We'll then proceed to Q and A. Regarding our CEO transition, as we announced a few weeks ago, the Board appointed Ravi Kumar to succeed Brian Humphries as CEO. Brian was a resilient leader providing a steady hand as he steered the company through various challenges including the global pandemic.

Speaker 2

On behalf of the Board, management and all of our associates, I want to thank Brian for his contributions, which have helped to position Cognizant to capture a large Growing market and fuel profitable revenue growth beyond our short term challenges. We also Appreciate that Brian will remain with the company as a special advisor until March to ensure a seamless transition. As part of the Board's strategy to help Cognizant achieve long term sustainable growth, we also announced today a new Board appointment. Eric Branderes, a proven financial executive and public company director with demonstrated experience Supporting growth in technology and in the Energy Industries has been appointed to serve as an independent director on the Board. Eric brings significant experience in finance, accounting, M and A execution, risk management And ESG and corporate governance to Cognizant, and we welcome them to the Board.

Speaker 2

The appointment comes as our Board continues to strive Towards optimizing its balance of director skills and tenures as part of its ongoing refreshment program. With Eric's appointment, The Board has appointed 5 new independent directors over the last 4 years. Maureen Breakeiron Evans, A member of the Board since 2009 has also advised the Board that she will not stand for reelection at Cognizant's 2023 Annual Meeting of Stockholders. On behalf of the entire Board, we thank her for her more than a decade of astute guidance, exceptional leadership And dedicated service to Cognizant. Given these changes to the Board, our governance committee, our committee chairs And myself will perform a comprehensive evaluation of committee composition with an aim toward balancing representation of Board tenure And appropriate key skills and qualifications on our committees.

Speaker 2

These were topics that I, along with other members of the Board, had the Pleasure of discussing with several of our largest investors during our annual governance roadshow in the Q4. Now before I turn the call over to Robbie, let me share a little bit about our enthusiasm for his leadership. Over the past few years, Cognizant has navigated a dynamic uncertain market while strengthening its operational and financial fundamentals. Heading into 2023, the Board believes that Cognizant has established a solid operational foundation And now needs to move toward accelerating growth. This agenda requires a focused growth mindset driven from the C suite.

Speaker 2

Robbie has this mindset. He brings a passion for building teams and driving growth in our industry and we're confident that he's the right leader to take Cognizant into our next phase with a goal of ultimately delivering significant returns to our shareholders. Ravi also brings to Cognizant best in class operations, transformation and leadership expertise at a global scale From a stellar 20 year track record of emphasis. During his tenure, he oversaw the company's global services organization And drove growth across its global industry segments. Ravi is a proven strategist who secured significant IT services deals.

Speaker 2

He led international business operations in India, Latin America, Japan and China, and he pioneered the creation of digital Talent pools in the U. S, Europe and Australia. Importantly, during his time at Infosys, Robbie earned a reputation as a people focused leader with a deep rooted commitment to teams and associates. Since he joined us a few weeks ago, Ravi has proven out this reputation as Cognizant Associates have warmly welcomed him to the team And are deeply enthusiastic about his leadership. We're confident that Robbie will help us further our efforts to support engagement and trust internally and drive retention amongst our high performing leaders and associates.

Speaker 2

As we look forward under Robbie's leadership, Cognizant will have a sharp focus on 2 key priorities. 1st, we'll be focused on meaningful acceleration of revenue growth. Our second key priority will be ensuring that Cognizant is the employer of choice in our industry. Ravi is the right leader to achieve this vision and the Board looks forward to partnering with him. I'll now turn the call over to Ravi To introduce himself and to share some additional perspective.

Speaker 3

Thank you, Steve, for that very warm introduction. Good afternoon, everyone. My appointment as CEO is one of the proudest moments of my life. I'm excited as well as humbled by this opportunity to lead Cognizant, a company I've long admired, Closely watched and completed against. As I've experienced, Cognizant has a diverse, highly skilled and a fully engaged Board.

Speaker 3

I'm grateful for the Board's trust and support and for their efforts to lay the groundwork for me and the company to flourish. I'm also very grateful to my predecessor, Brian Humphries, who led the evolution of Cognizant's business. We refreshed and broadened the strategy, extended the company's portfolio and drove the implementation of more rigorous systems and With a very strong foundation in place, I'm not going back to the drawing board. Instead, I plan to move forward by building on and refining what already exists, which will include calibrating a thinking to a growth mindset. I want to see us offer the full breadth of our industry specific solutions, whether developed organically Or acquired through targeted acquisitions to a large installed base of clients and invest for growth.

Speaker 3

A few days after my appointment, I participated in Cognizant's annual sales kickoff, which was held in Abu Dhabi. At the summit, a 1,000 of our client facing associates came together from around the world to take stock of all of what we have And what we need to accelerate growth. I was so deeply moved by the warmth and the enthusiasm I was greeted with. We set ourselves a goal to be an employer of choice, which we believe will be a pivot for growth. I plan to spend the next Several months meeting with so many associates, clients, partners and shareholders as much as I can.

Speaker 3

I will listen carefully with an open mind, build trust and learn all I can about how best to unlock more value for clients, Make progress in accelerating top line growth and drive long term shareholder value. Because I like to be highly visible with Clients and associates, my plan is to meet with 100 clients over 100 days, whether in person or virtually, and to visit With as many of our global teams as I can, later this quarter, I'm spending several weeks in India And visiting associates at many of our locations across the country. Having joined Corp Business just 3 weeks ago, I'm early in my learning curve I need time to get my hands on the pulse of the business. That said, I've already identified several areas that are tied to operating with a growth mindset To focus on immediately, today I will look to talk about 3 of those important areas. First, making Cognizant an employer of choice in its industry.

Speaker 3

2nd, strengthening our ability to win large deals. And third, enhancing our operating discipline. A quick word on each, starting with employer of choice. Spend time in the IT Services Industry and you quickly realize that sustained success In this on the quality, dedication and scale of our talent. The value we create for clients comes from the knowledge and the skills of our associates.

Speaker 3

Because the client experience and the employee experience are so tightly linked, we have the opportunity to Create a self reinforcing cycle. 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. That's why one of our goals and one of my specific important roles As the CEO is creating conditions for all our associates to excel. I'm committed to investing heavily in providing associates with continuous Learning, upscaling and leadership development, all aimed at increasing the professional relevance.

Speaker 3

I believe the number one factor that will define success for Cognizant is to become the employer of choice in our industry. Everything else must be based on that foundation, especially the ability to consistently deliver industry leading growth, which is the absolute focus Let's turn to large deals, which Another top priority given how essential they are to building commercial momentum and enhancing our stature as a provider of business outcomes aligned by industry. Accelerating large deal bookings that will align with our risk appetite requires the client centricity And competitive self confidence to walk the corridors of our clients, cultivating and mining existing relationships while hunting for new ones. And always showing up with an informed point of view. Over the last year or so, Cognizant has advanced its solutioning capabilities along with its Project and program management processes.

Speaker 3

We have become better equipped to solution and manage large deals And I plan to build on this foundation to reenergize our efforts. In particular, I want to instill a greater sense of pride and empowerment I'm on the client partners and delivery teams to encourage a faster, more agile response to client needs. I have a weekly standing meeting during which I review 10 large deals and do everything I can to help our teams drive these deals over the finish line. Last week, we were pleased to announce the signing of a 10 year $1,000,000,000 renewal contract with a long standing client CoreLogic, demonstrating our capabilities and the confidence our clients place in us. The 3rd area of focus is ensuring operational excellence across the company, including our approach to large deals and fulfillment in general.

Speaker 3

We are building out an organizational structure designed to bring together a Continuum of activities such as industrialized delivery with high productivity rates, market competitive cost takeout initiatives, Contract Lifecycle and Risk Management, consortium led deals and more. As one Cognizant team, we are also working on internal simplification as a team. We will carry forward to help achieve the company's full potential. With the market for tech talent showing some early signs of improvement, we are working to optimize our fulfillment of existing engagements, Unleash our entrepreneurial spirit and rejuvenate the growth mindset. Switching gears for a moment, I would like to offer a few perspectives on the long term demand environment for technology services.

Speaker 3

I believe we are in a golden era of technology And that software is the new alchemy for every business and industry. As the world prepares for a post pandemic reset Of the way we work and live our lives, we see more organizations accelerating their embrace of digital technologies. Industries at lower levels of digital maturity like healthcare, life sciences and manufacturing are stepping up their tech intensity. Well, those that are more digitally mature like financial services, retail and communications are staying invested in digitizing the landscapes. We also interestingly see workplaces rapidly adapt digital technologies as employees get comfortable with Continuously toggling between hybrid and physical workplaces.

Speaker 3

In an era of globalization that has spanned Several decades, enterprises have turned to tech services companies to enable the businesses to scale and globalize. Today, Every industry is a tech industry. Technology will be deeply embedded in the core of every business, every product and every service. Therefore, the use of deep software engineering capabilities to transform the core of businesses will be a big player for tech services firms like Cognizant. So too will be the market opportunity that comes from 1 digital companies that outsource the technology core and operations.

Speaker 3

The cloud, needless to say, will continue to remain the biggest general purpose technology we have seen in decades And we deeply embedded as a digital pillar in every business. Cloud migration, modernization, application Services will continue to create significant market momentum. Growth will also be driven by new cloud services like data on the Cloud data exchanges, new SaaS services and cloud security services. Clients are aware of our deep alliances with the hyperscalers And new best in class SaaS companies as well as our ability to co innovate with these partners, we truly believe clients will continue to turn to us to help orchestrate those cloud capabilities. The shift to the cloud and 5 gs have also accelerated IoT adoption As use cases grow with better connectivity and proliferating devices, on that score, last week, we further bolstered our IoT embedded software Engineering capabilities with our agreement to acquire Mobica, an IoT software engineering provider.

Speaker 3

Mobica Also strengthens our near shoring capabilities in Eastern Europe, which is home to nearly 8,000 of our associates. We see a strong push now to bring AI into business landscape. So the expectation that AI will reengineer enterprises as completely as enterprise software did To fund their investments in digital transformation by executing cost and efficiency agendas. These same clients are now asking how we can help them achieve their cost reduction ambitions and underwrite savings for their digital initiatives. Given our broad capabilities, we can help clients whether they need to drive efficiency gains, innovation or an end to end transformation of the business.

Speaker 3

I quickly want to turn for a moment to India, home to about 3 quarters of Cognizant's workforce. India is likely to be the world's technology

Speaker 4

talent hub for

Speaker 3

the next decade. India's population has a demographic profile And digital talent pool unmatched by any other country. And NASSCOM forecasts some 2,000,000 IT professionals will be added to India's Talent pool over the next 3 years. We'll continue to capitalize on the surge in the IT talent in India as we intensify efforts to recruit from India's Tier 2 cities as well. Our large associate base in India is an ongoing source of strength and differentiation for Cognizant and one in which we will continue to invest.

Speaker 3

As confident as I am in Cognizant's prospects, I'm fully aware as we have signaled with our guidance for Q1 for quarter 1 that we have a great deal of work ahead of us. It will take time to rebuild the pipeline and go after large opportunities. Please know we put a lot of thought Into our decision to hold off on providing full year guidance. But before making commitments, I can stand behind, I really need to spend more time digging into the business and Talking to associates and clients. Keep in mind that we are building on a strong foundation.

Speaker 3

We have a long client relationships with broad portfolio of industry specific solutions, a robust and resilient global delivery network, A significant opportunity for international expansion and most important, a reenergized and highly motivated team. I intend to catalyze Cognizant's heritage culture of bold ambitions, our entrepreneurial spirit that emphasizes being fast, agile and adaptable And of course, our camaraderie and teamwork. I'm super energized to lead Cognizant into the next era of growth and I'll put everything I have into making this As I've shared with all our associates, our mantra now is to bring back growth and be the employer of choice. Now it's my pleasure to turn the call over to Jan, who will take you through the financial details of the quarter before we take over questions. Jan, over to you.

Speaker 4

Thank you, Ravi, and good evening, everyone. 4th quarter and full year 2022 revenue We're above the high end of the guidance range we provided on our Q3 earnings call in November and in line with the revised expectations we provided On January 12. Operating margin was negatively impacted by the previously disclosed non cash charge in the quarter, which which I will cover in more detail later. As said of this charge, we were pleased with the continued progress towards our operating margin goals, driven by commercial discipline, The depreciation of the Indian rupee and SG and A leverage. During the quarter, we made progress improving fulfillment, driven in part by a meaningful reduction in voluntary attrition, which declined to 19% on a quarterly annualized basis From 29% last quarter.

Speaker 4

This has allowed us to further decrease subcontracted usage and will enable us to put greater focus on driving improved commercial momentum in the quarters ahead. That said, the macro environment remains uncertain and we continue to see pockets of weakness across several key verticals. Now moving on to the details for the quarter. 4th quarter revenue was $4,800,000,000 representing an increase of 1.3% year over year or 4.1% in constant currency. Year over year growth includes approximately 40 basis points of growth from our acquisitions and a negative 60 basis points impact from the sale of Samlink Completed at the beginning of 2022.

Speaker 4

Full year 2022 revenue was $19,400,000,000 representing an increase of 5% year over year or 7.5% in constant currency. Year over year growth includes approximately 100 basis points of growth from acquisitions and a negative 60 basis points impact from the sale of Samlink. In Q4, digital revenue grew 4% year over year or 7% in constant currency. This resulted In full year 2022, digital revenue growth of 11% was 13% in constant currency. Digital mix was unchanged from last quarter at 51%, up 2 points from the prior year period.

Speaker 4

Q4 bookings increased 12% year over year, including the large agreement with CoreLogic that we announced last week. This opportunity is primarily a renewal of existing work with some modest increase in scope during the latter years of the contracts. For the full year, we recorded bookings of $24,100,000,000 and a book to bill of approximately 1.2 times, unchanged from the trailing 12 month book to bill we reported last quarter. Outside the large renewal, bookings momentum remained muted Exiting this year, this has put pressure on our Q1 outlook, which I will cover shortly. Moving on now to segment results in the 4th quarter, where all growth rates provided will be year over year in constant currency.

Speaker 4

Within Financial Services, revenue declined 1%, reflecting a negative impact of 180 basis points related to the previously disclosed sale of our SandLink subsidiary. This was partially offset by growth among public sector clients in the UK And insurance clients. The revenue weakness is being driven by our banking and financial services practice, which we expect We'll remain under pressure for the next several quarters. Ravi, the entire team and I are laser focused on reevaluating our go to market strategy, Enhancing the strength of this portfolio and have initiated a series of actions, including certain Leadership changes that we believe will give us the best opportunity to improve our performance. We are seeing early signs of success With select global banking relationships, where we have successfully shifted our portfolio mix towards higher growth on strategic areas.

Speaker 4

This gives us confidence that we are moving in the right direction. However, more meaningful improvements will take time to implement. Health Services revenue grew 5%, consistent with last quarter. We experienced similar growth among Both Healthcare and Life Sciences clients, which partially reflects some normalization of demand that had been driven by COVID. As we discussed last quarter, we have seen some pockets of softness within the segment driven by the macro environment and regulatory complexity.

Speaker 4

Despite these challenges, we continue to view our health sciences capability as industry leading and remain excited about the growth opportunities over the medium term. Products and Resources revenue grew 7%, a modest deceleration from last quarter. Revenue was negatively impacted by slower growth among manufacturing, retail and consumer goods customers, which we believe primarily reflected the softening of the microenvironment. This was offset by continued strength among consumer goods, automotive, logistics and utility customers. Communications, Media and Technology revenue grew 9%.

Speaker 4

Growth again was led by our technology business, where our work with digital native clients Has driven growth in our core portfolio. Our growth has moderated somewhat as growth among some of our largest clients have slowed, but remains positive. We are closely monitoring trends and developments affecting the tech industry. Continuing With year over year growth in constant currency from a geographic perspective in Q4, North American revenue grew 3%. Growth was led by CMT and Health Sciences.

Speaker 4

Our Global Growth Markets or GGM, which includes all revenue outside of North America, grew It also included a negative 220 basis points impact from the sale of Samlink. Growth was again led by the UK, which grew 16% and included double digit growth in Financial Services, including public sector clients. Now moving on to margins. In Q4, our GAAP And adjusted operating margins were 14.2% as there were no non GAAP adjustments in the quarter. On a year over year basis, both GAAP and adjusted operating margins declined by 110 basis points.

Speaker 4

This includes The previously disclosed negative 120 basis points impact from a non cash impairment of capitalized cost Related to a large volume based contact with a health sciences customer. Our operating margin benefited from SG and A leverage, While gross margin pressure from increased compensation costs was partially offset by delivery efficiencies and disciplined pricing. We also experienced a meaningful tailwind from the depreciation of the Indian rupee, which represented an approximate 110 basis point benefit Net of hedges year over year. Our GAAP tax rate in the quarter was 27%. Adjusted tax rate in the quarter was 26.8%.

Speaker 4

Q4 diluted GAAP EPS was $1.02 In Q4, adjusted EPS was $1.01 down 7% 8% respectively. GAAP and adjusted earnings per share were each negatively impacted by $0.08 in connection with the impairment of capitalized costs related To a large volume based contract with the health sciences customer. Now turning to the balance sheet. We ended the quarter with cash and short term investments of $2,500,000,000 or net cash of $1,900,000,000 DSO of 74 days Was flat sequentially and increased by 5 days year over year. Free cash flow in Q4 was $612,000,000 Representing approximately 115 percent of net income.

Speaker 4

This brings full year free cash flow to $2,200,000,000 representing approximately 100 We are pleased with our performance in 2022. However, A change in U. S. Tax law that became effective last year now requires companies to capitalize rather than currently deduct R and D expenses. As a result, like many other companies, this will impact our free cash flow in 2023.

Speaker 4

We expect capitalization of R and D costs for tax purposes to negatively impact free cash flow by $600,000,000 Which includes deferred payments for the 2022 tax year as well as increased payments for 2023. With this change, we expect our cash conversion ratio to be below our target of 100% of net income in 2023. Moving on to capital deployment. During the quarter, we repurchased approximately 5,000,000 shares for $300,000,000 under our share repurchase program and returned $139,000,000 to shareholders through our regular dividend. This brings total capital return to shareholders through share repurchases and dividends to $2,000,000,000 for the full year.

Speaker 4

In the quarter, we also completed 2 acquisitions, Austin CSI and Integration for a total purchase price of approximately $370,000,000 In addition, we announced the acquisitions of Mobita and the professional services and management practices of OneSource Virtual. These acquisitions are expected to improve our digital revenue mix, enhance our consulting capabilities. Our capital allocation framework remains unchanged. Over the longer term, we continue to expect to deploy a balanced capital allocation policy, Returning to an aggregate of approximately 50% of free cash flow to shareholders in form of dividends and share repurchases And allocating the remaining 50% to inorganic investments. Turning to our forward outlook.

Speaker 4

As Ravi mentioned, and you will see in our earnings materials, we are only providing revenue guidance for the Q1 of 2023. Given our bookings momentum in 2022 and the uncertain macroeconomic environment, we expect Our full year 2023 performance to be below the multi year goals we provided in late 2021. We intend to provide an update on the full year 2023 expectations for revenue and adjusted operating margin next quarter. For the Q1, we expect revenue in the range of $4,701,000,000 to $4,760,000,000 Representing a year over year decline of minus 2.5% to minus 1.5% or a decline of Minus 1% to flat in constant currency. Our guidance assumes currency will have a negative 150 basis points impact as well as an inorganic contribution of approximately 100 basis points.

Speaker 4

We look forward to sharing more as Ravi continues To get up to speed. As he discussed, we remain very excited about the medium term market opportunity. We also believe But while the current macroeconomic uncertainty has led to some pockets of slowdown, it also presents an opportunity for Cognizant To help our clients operate more efficiently, while continuing to invest in new digital capabilities. With that, We will open the call for your questions.

Operator

Thank you. Ladies and gentlemen, at this time, we will be conducting a question and answer session. Please limit yourself to one question and one follow-up. Our first question comes from the line of Ashwin Shivakar with Citi. Please proceed with your question.

Speaker 3

Thank you and congratulations and welcome Ravi and You guys well, congratulations to you. It's good to reconnect. I think my first question is, Growth mindset, I get that. What are some of the explicit steps you might need to take incrementally to return to that Growth mindset, if you can speak to your early view on what's needed for sales investments, capability investments, Just the G and A investment to chase large contract, things like that? Thank you, Ashwin, for that question.

Speaker 3

Good to

Operator

connect with you.

Speaker 3

Having spent a significant Time in this industry, I would say to build a growth mindset, there are a number of things we need to do. But I would probably highlight 3 of them as I talk through today, the most important priorities. 1st and foremost, Cognizant has to be an employer of choice In this industry. What I mean by that is Spending time in the IT industry, IT service industry, what I mean by that is, you create a self reinforcing cycle With employees and clients, sustained success is based on quality, dedication and scale of the talent, But client experience and employee experience are so tightly linked. We have the opportunity to build that self reinforcing cycle with engaged talent and a passion for clients and a growth mindset That tracks the best clients, so that whole flywheel has to be self reinforcing.

Speaker 3

It means a lot of things, all the way from retention to upscaling, to leadership development, to Infusing the project and program leaders, remember, we are a company of projects and programs, which essentially means As they walk the corridors, they're minor clients, these project leaders and equally they talk to our associates every day. So that is Starting point of where you would try to build the trust with that layer and continue to Create that self reinforcing, what was cycle as I call it? I think you talked about large deals. I think large deals Has investments on both sides, investments on deal makers, deal influencers, Ability to create that momentum by supporting Our client initiatives in various transformational Initiatives of theirs, but equally, at the back end, you have to start to work on solutioning capabilities And the ability to build a continuum all the way from addressing cost takeout initiatives to managed services initiatives To large deals will come with people take over opportunities and of course productivity improvements. There's a lot of tooling and infrastructure.

Speaker 3

I think Cognizant already has some of it. You have to build on it and then go behind this It's equally important that we build operational discipline, which also helps us to create the growth mindset All the way from fulfilling those deals to building market competitiveness on cost takeout initiatives to Contract lifecycle and risk management to consortium led deals and partnerships and a whole bunch of things. Well, do we have all of this in place? Yes. I think a lot of these things have already been set in the I would say in the last few years at Cognizant.

Speaker 3

I have to orient this to a growth mindset and start to double down on the opportunities which are there in the market. In the short run, some of this will mean Additional investments, but in the medium to long run, you have to create that Pool of investments inside by taking out costs so that you can then sustain that momentum for the future. Got it. Thank you for the obvious thought you put into that answer. The second Second question is on the healthcare contract that was a problem in the quarter.

Speaker 3

Any granularity on sort of separating out the top and bottom line Impact and is it ring fenced now in other words that is the margin impact taken into account entirely in 4Q or is there forward looking impact and what's the forward looking revenue impact as well?

Speaker 4

Yes. Maybe I'll take this. The Health Sciences Clients that we have is a volume based contract based on the performance of that healthcare client. And so as the outlook of our clients has changed, we had to adjust our revenue expectations going forward, which led then to A charge that we have to take for the expected lower volumes of incoming business to us in essence. And so The revenue impact is really going to be baked into our natural revenue guidance and forecast.

Speaker 4

So the charge that we have been taking is a discrete charge, it's sort of $60,000,000 and that is a non cash charge of Prior capitalized implementation costs that we are now taking out of the contract, so future volume changes of this client could impact Our calculation on these capitalized implementation costs as well, so there's still Outlook, we obviously work very hard with our client to drive a great revenue growth. It's our interest and the client's interest. But there is still a possibility of pending on the revenue development and the market performance Off that line that we could be impacted in the future as well.

Speaker 3

Okay. Thank you.

Operator

Next question comes from the line of Tien Tsin Huang with JPMorgan. Please proceed with your question.

Speaker 5

Hey, thanks so much. And got to say, Steve, nice to hear from you upfront. It's been a while. So, I want to ask some of the Ashwin To Ravi here, just the goal of being the employer of choice and having a growth mindset makes a lot of sense. How long do you think it would take For to change the culture to get to that level, I'm imagining it can't be a quick fix, but maybe you feel differently.

Speaker 3

That's a good question. I'm just 3 weeks into the job. So I'm continuing to That's what we have, what we need to do. It's a virtuous self reinforcing cycle, as I said, As much as it looks easy, it's if you're on it, it's easy. If you're not on it, it's not.

Speaker 3

I'm going to be on a listening tour For the next few weeks months, meeting clients, meeting associates, meeting partners, And I'll come back with assessment. I think we have built enough both on client and employee infrastructure, organizational infrastructure. Now I have to refine it and reset it for growth. That's how I see it. I want to build on it.

Speaker 3

We're not going to go back to the drawing board. We're going to build on what we have and refine it. And as we refine it, we'll make some changes and get there. With related to employees, a lot of our 2 thirds of our employees work out of India. So India is an integral part of our strategy to differentiate and I'm going to spend the next few Leaks in India as well, later part of February, and I'm meeting 100 clients in 100 days.

Speaker 3

And this is a goal which I've set for my own self, so that you get to know the pulse, you get stay focused on large deals. In fact, I'm doing a monitoring of 10 large deals every week and we're continuing to keep the focus on commercial momentum. So it's in flight transformation as I call it. You continue to do this, but you continue to look for the medium to long term Sustained momentum, how you created. That's how I see it.

Speaker 3

It's still a question I will probably like to answer once I spend a few more weeks going through the listening tour.

Speaker 4

Maybe I'll give Ravi also a Penny, breather here and talk about the improved attrition, which is certainly one first step into the right direction of becoming a More attractive employer and seeing it reflected. So clearly, the dynamic in the labor markets have shifted also, but we also believe that the investments that we have made Not only in regular and competitive merit cycles. You may remember we announced In the last quarter that we had accelerated our this year's merit cycle to the Q2, which is also important for the modeling of you guys Into the Q2 and that we have made huge progress on internal promotions, career pathing And learning and development and education, etcetera, as we have increased the number of our college graduates into our permit. So I think we have seen now a year of this permit from nuts and bolts piece to stabilize, and we were Very pleased with this relatively steep drop in attrition in just 1 quarter. So We feel we are off to a good start here.

Speaker 4

And then I think Ravi's focus on management, on enthusiasm, on growth And aligning will help and then we'll kind of continue to refine those investments as we see needed. But I think we have already End of the year actually on that side with a big step forward.

Speaker 3

And also the talent Supply chain, we have been able to streamline it, strengthen it and be ready for fulfillment and opportunities which our clients are looking forward to.

Speaker 5

Yes. Then if it's okay, if I can ask that as my follow-up then with given that 10 point drop in attrition and you've Still hired a little bit, the utilization rates did drop. So from a modeling perspective, not to bore people, but anything to guide us to in the short term on some of those KPIs because Because they are moving quite a bit here?

Speaker 4

Yes. We were obviously on this utilization metric also a very detailed answer. In this quarter, The slight decrease in utilization is actually more driven by the relative higher percentage of Gen Z hires into our permit, Which are not as utilized in the young age and actually a return to normalized vacation taking compared to the COVID years of where we had Abnormally lower vacation period. So those were the biggest factors. So I wouldn't model too much into the utilization.

Speaker 4

Obviously, we need to Drive growth and as we now have better fulfillment opportunities, but in this quarter actually the utilization, those were the 2 big Factor, I think, Jim.

Speaker 5

Okay, perfect. Thank you, Jan and Ravi. Appreciate that and look forward to getting to the updates and safe and healthy travels. Thanks.

Speaker 4

Thank you.

Operator

Our next question comes from the line of James Faucette with Morgan Stanley. Please proceed with your question.

Speaker 6

Great. Thank you so much. I want to follow-up a little bit on Tien Tsin's question as well as Jan and Ravi's comments is, If we look at, Ravi, your initial stages of evaluating and listening to customers and what you're seeing in the business, If I put that together with Jan's comments around investment, that seems to be helping in attrition, etcetera. I'm wondering if The 2 of you can give some perspective on if there's anything that stands out right now as maybe points or places where there Could have been under investment that you'd like to direct resources and how does that impact the way that you're thinking about you and the Board are thinking about the right objectives From a cost and profitability standpoint.

Speaker 4

Ravi will chime in after I give you a more technical thing. I think as we Mostly developing these plans. So we're clearly not at the end of the job, otherwise we would give guidance today. But When you think large deals and calculate a certain large deal volume, I think deal characteristics of large deals have impact Onto our margin profile. And when we think about that, we need to build kind of our culture To leverage the relative margin strength, if you exclude our healthcare charge And our pricing discipline and our delivery discipline, so that it allows us to be competitive for these larger deals That may cause dilution initially and then ramp up to their full margin potential.

Speaker 4

So I think the biggest impact Practically would be to figure out for us assuming the success in our large deal focus Of what that would mean for the overall P and L structure, I think that's going to be the biggest one. There are going to be other investments that Ravi is going to be proposing, but I think we're going to be managing those a little bit more within the framework of an SG and A volume that we have already. Not to Take that away from you, Ravi, but I think

Speaker 3

Liana, I think you've covered it so nicely. The one thing I would probably add is, I think in the last 1 to 2 years Cognizant has invested heavily on organizational Structure to take large deals on a continuum all the way from managed services to transaction based pricing to Cost takeout initiatives to digital transformation on that continuum. Now is the time To leverage those investments and take those large deals and be competitive on those large deals. So in a way, I would say a large part of it is done. We have now strengthened it and we have to orient it to the market for the opportunity which is So that's broadly how I see it.

Speaker 3

As I keep Saying it isn't going back to the drawing board, but I'm going to build on what we have. We're going to refine it. As we We have to make some changes, we're going to make those changes, but we'll be agile enough in the market to seize the opportunities we have.

Speaker 6

Appreciate that. And then just as a follow-up, Ravi, how are you thinking about and what's your perception of the current economic environment? Obviously, as you Go to listen and engage with customers, etcetera. It seems like a big part of the challenge for you will be to Parse out feedback that is specific to Cognizant and has impact on how you Should move the business going forward on a sustained basis versus maybe some things that are happening near term. So just wanted to hear how you're Thinking about the current economic environment and the lens that you're looking at some of these comments or listening to these some of these comments through.

Speaker 3

Yes, that's a good question and I'm going to lean into Jan as well to chime in. Over the years, ID Services has gone from a homogeneous landscape to a heterogeneous landscape. They're different swim lanes. In an uncertain economic environment, you're going to see discretionary spend being a little softened. Large digital transformation engagements will start to become modular in nature.

Speaker 3

But equally, you're going to see cost takeout initiatives, vendor consolidation initiatives happening on the other end. I would say that's a different swim lane. But enterprises are continuing to invest because not only are they investing on the consumer side of digital, they're also On the employee side of digital, because employees today are interacting with There are organizations on a digital platform because of the hybridness of how work and workplaces are. So I would say It's a duality of sorts. On one side, you would see softness.

Speaker 3

On the other side, you would see cost And when does consolidation kind of happening? Depending on the industry you look for, there is there are industries which have lesser Tech and digital intensity and the industries which have higher tech and digital intensity and some of them are using the digital platform to transform and deliver. In fact, I would say digital technologies is almost like a deflationary force in an inflationary economy. So some of our clients are using digital technologies to do so. So it's a mixed bag.

Speaker 3

It's Because of the heterogeneity, I would say it's a mixed bag. Each single day has its own characteristics. Jan, do you want to chime in?

Speaker 4

Yes. Like I'll Give you a little bit more background maybe about our bookings performance and what where we have seen the softness and geographically and by digital. We We did have a relatively solid bookings growth in digital this last year, and I'm giving you full year numbers. It's about I'm going to highlight 16%, 18% or something growth in the digital bookings world. And then We saw actually the weakness by sector really concentrated as you would expect in our Financial Services group, where we saw the biggest decline in Bookings volume for us.

Speaker 4

And as Ravi illustrated in his comments, It's kind of almost in every industry we're trying to sort out, are we having some industries stronger and others, but we do have success stories By industry sector, and we have declines in industry. So it seems to be a little bit client specific of what we need to watch out. You have talked obviously, as good now looking forward, we enter the year with one of our largest pipelines Ever basically. Now a lot of work, which is for Ravi and the market teams to achieve is to convert that pipeline into Qualifications and into bookings numbers, so there seems to be a lot of opportunity still out in the thing. Obviously, the mix of that business is shifting a little bit.

Speaker 4

We hope we want to drive a higher participation and higher bookings number for larger deals, Which we haven't had in the past and that's the true revenue and incremental revenue opportunity that we're aiming to capture. And but there is still a very solid market out there even though the demand on a Sequential basis has gotten a little bit softer, if that makes some sense. So we're going to be laser focused obviously on converting this opportunity into Bookings and then and to revenues, but the underlining market remains attractive from my perspective.

Speaker 6

That's great. Thanks for the color, Ravi and Jan.

Operator

Our next question comes from the line of David Togut with Evercore. Please proceed with your question.

Speaker 7

Thanks so much. Congratulations, Ravi and Steve, it's really good to hear your voice again. Could you, Jan, give us some guardrails around gross margins in 2023, not looking for anything precise, but maybe just help us think through Some of the headwinds and tailwinds, you had a number of wage increases in 2022. Obviously, Attrition coming down helps a little bit, but could you help us think about what the gross margin range might be this year?

Speaker 4

Well, that I cannot do, but I think I can give you a few, David, good to hear your voice as well. And I give you a few pointers that I think are kind of important for the modeling that we had prior disclosed. So the usual merit increase that Puts negative pressure on our gross margin in the 4th quarter will now occur in the second quarter. So that will Disturb a little bit our pattern of regular margin development throughout the year. If anything, I think You know that second and third quarter traditionally are our strongest margin patterns and then we have the 4th quarter due to the maritime, that will shift a little bit.

Speaker 4

But other than that, we are not really thinking that the general dynamic of our pattern of the year is going to shift In a very meaningful way. So I think it's like even though past performance is no guarantee for future performance, but Like when I think about our year, I think the principal dynamics remain unchanged. We have seen maybe as this one point, I'm getting into trouble here as I look at Tyler, but we have seen actually moderate to good success with our pricing initiative. And so The contribution of our pricing initiative to gross margin in the 4th quarter Was the highest. So we have really built quarter after quarter momentum and was 50% higher than all other quarters together.

Speaker 4

And so We're entering with a little bit of pricing momentum and then we have that's Going to be partially offset or offset by our wage increases in the Q2. And then as you said, coming up with some sort of metric, which How attrition is going to help us in revenue or fulfillment and some efficiencies It's going to be then for the modeling. That's what we also undergo right now, David. So I really don't have those numbers yet For you and we're planning to do the update in the Q2 then.

Speaker 7

Understood. Thanks so much.

Operator

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

Speaker 7

Hey, guys. Thanks for taking my call. Congrats to Steve and Ravi. Ravi, maybe just to start with you. I know you obviously need time to study the organization, develop your plan, but just at a high level, is your initial sense that Cognizant has more room to improve in terms of Strategy or in terms of execution?

Speaker 3

This is how I will see it and of course I need more time to assess and as I said it's a listening tour With both clients and my associates. But the way I see it Is the opportunity ahead of us? I think we have an extraordinary Set of client relationships, extraordinary talent pool, looking from outside, I've always been impressed by the entrepreneurs spirit, The bold ambitions and some very good teamwork at Cognizant. The one strength I've always been excited about at Cognizant is the confluence of industry vertical Experience with technology expertise, very unique spot. It's a very, very unique spot.

Speaker 3

So I would almost see this as a way forward strength and Look for opportunities which will fit the bill. And I do believe that We have the necessary organizational infrastructure to attract employees, retail employees, Attract clients, retain clients and also win large deals. That is how I see it. The Actually in front of us is what I am kind of configuring and calibrating the firm to. Instead of actually looking back, I'm looking forward and trying to Gear up for that opportunity with what we have and what we need to build.

Speaker 3

So that's broadly what I can say, how I'm actually trying to approach My way forward direction.

Speaker 7

Very helpful. And just as a follow-up, this might be more for Jan, but How close are we do you think to fully remediating the fulfillment issues? And then just any at least directional commentary you can give us on 1st quarter operating margins? Thanks guys.

Speaker 4

Yes. The fulfillment in the 4th quarter really improved very meaningfully and it gives us part I think it's part of the optimism we have that we can go to clients And fulfill their needs, which as we had talked in the 3rd Q4 in the 3rd quarter was hampered at times So I think the improvement in fulfillment will translate into accelerated and enhanced sales activity. That's at least Part of our thesis that we have and it should obviously lower our need for recruiting and have efficiencies in the support for all of this We'll make clients happier and so forth. So the underlining engine running smoother, It's really a shift compared to where we were throughout last fiscal year. So I think that's really that gives us hope and gives us optimism Yes, we're not giving a 1st quarter margins, unfortunately, so I can't help you with any direction there.

Speaker 3

Yes. So just to add to what you had said, I think my initial few weeks, one of the observations is, I think our talent supply chain Is grinding well or it's kind of moving very well. Some Some of the clients I've spoken to in the last few weeks have started to tell us that We can start to get some of the demand move to Cognizant with your fulfillment starting to look good. So I'm actually very excited about the progress we've made on fulfillment. I think we are ready to take more And we are ready to continuously sharpen the talent supply chain for the opportunity with our clients.

Speaker 3

Our clients are starting to See the traction with us. Thanks for the comments.

Operator

Ladies and gentlemen, that is all the time we have or questions. I'd like to hand the call back to management for closing remarks.

Speaker 1

Great. Thank you all for joining us. We look forward to catching up with you in a couple of months on our first

Operator

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful

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Earnings Conference Call
Cognizant Technology Solutions Q4 2022
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