Cognizant Technology Solutions Corporation (NASDAQ:CTSH) Q1 2024 Earnings Call Transcript May 1, 2024
Cognizant Technology Solutions Corporation beats earnings expectations. Reported EPS is $1.12, expectations were $1.11. CTSH isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Ladies and gentlemen, welcome to the Cognizant Technology Solutions First Quarter 2024 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. [Operator Instructions] Thank you. I would now like to turn the conference over to Mr. Tyler Scott, Vice President of Investor Relations. Please go ahead, sir.
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 first quarter 2024 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 Jatin Dalal, 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 now like to turn the call over to Ravi. Please go ahead.
Ravi Kumar: Thank you, Tyler, and good afternoon, everyone. Thank you for joining our first quarter 2024 earnings call. I’m pleased to report that during the quarter, we continue to make progress against the strategic priorities I laid out last year while navigating a challenging demand environment. We delivered revenue growth that exceeded the high end of our guidance range and expanded our adjusted operating margin year-over-year. Voluntary attrition improved again and we ended Q1 with trailing 12-month voluntary attrition for our technology services business at 13.1%, representing a decline of 10 percentage point’s year-over-year. And our next-gen program remains on track as we continue to focus on simplification and operational excellence.
As we have all seen in recent earning results for our peer companies and economic headlines, the demand environment remains uncertain and geopolitical risks continue. These dynamics are shifting near-term client spending priorities from discretionary projects towards projects that will drive near-term cost savings and fund innovation for the future. Now moving on to Q1 highlights, we delivered revenue of $4.8 billion, which was sequentially flat and represented a decline of 1% year-over-year, both as reported and in constant currency. We expanded our adjusted operating margin by 50 basis points to 15.1% as we continue to execute our cost optimization strategy and take out structural costs. First quarter bookings on trailing 12-month basis were $25.9 billion, an increase of 1% year-over-year.
While there is good sustained traction with our large deals, we saw softness in smaller deals in the range of 0 to 10 million total contract value, reflecting the tight discretionary environment. Our strong deal momentum in the quarter was evidenced by the fact we signed 8 deals each with a TCV of $100 million or more, compared to only 4 in the prior year period. We have also seen early green shoots in our efforts to diversify our large deals outside of North America. And in quarter one, two of the 8 greater than $100 million contracts we signed were in the APJ region. On a trailing 12-month basis, our book-to-build ratio of 1.3x remains strong, which we believe provides a healthy backlog of opportunities to improve revenue performance over the next several quarters.
We continue to grow our pipeline for larger deals and make progress against the goal of increasing the value of large deals in our bookings. From a segment perspective, demand trends were consistent with what we have seen in recent quarters. We saw sequential growth in health sciences and communications, media and technology, offset by declines in financial services and products and resources. While financial services have been impacted more meaningfully than other segments by weaker discretionary spending, we did see sequential growth among our banking and financial services clients, which represents about 60% of our financial services segment and are encouraged by the opportunities we are seeing in the overall pipeline, particularly within our intuitive operations and automation practice area.
We see several themes that we believe are helping drive demand for our services. These include clients’ continued investments in developing a modern technology infrastructure related to AI, cloud and digital technologies, data engineering, prioritization of hyper-personalization and customer experience projects and the need to deliver innovation. One example of infrastructure modernization this quarter was an agreement we signed with a new client, McCormick & Company, a global leader in flavor. Over the next five years, we will help transform and manage its global technology infrastructure, leveraging AI automated tools to enhance McCormick’s employee and customer experience while improving productivity and driving financial savings for our client.
Another example of modernization and hyper-personalization is our recently announced new strategic alliance with Shopify and Google Cloud. Under this alliance, we will help drive digital transformation and platform modernization, enabling global retailers and brands to unlock business value from generative AI. We believe today’s retailers must drive a modernization agenda while investing in innovation to elevate their end users and customers’ experiences. Earlier this week, we signed a strategic agreement with Telstra, Australia’s leading telecom and technology company to elevate their software engineering capabilities and enhance their customer’s experience. We believe this is a key strategic win in our APJ market and we will leverage our AI tools to drive innovation, enable more efficient software engineering and ID operations, and decommission legacy systems to improve operational efficiency and support their employee experience by building them a superior engineering experience.
And as a fourth example, we extended our long-standing relationship with CNO financial group during the quarter. Under this expanded agreement, we will implement cloud and digital technologies to help CNO deliver more personalized digital and convenient solutions to the customers. We will also leverage generic technologies to help drive efficiencies across infrastructure applications, enterprise software and engineering services. Our clients’ desire and need to drive innovation is apparent in all our client interactions, but funding for that innovation is being impacted by demand uncertainties in our clients’ own end markets. The timing of a return in discretionary spending remains unknown, but our thesis remains simple. We plan to be prepared when it returns, but continuing our organic investments in learning and development, people, platforms, and innovation, while supporting those initiatives with inorganic capability enhancing investments.
On the client side, data from our project-level client feedback process for the first quarter of this year shows a 39% improvement in our net promoter score regarding our project delivery quality over the last two years. We believe this is a result of a self-reinforcing cycle we created through tighter client collaborations since the beginning of 2023. As a testament to our long-time focus on helping clients innovate, during the quarter, Fortune magazine recognized Cognizant as one of the America’s most innovative companies in 2024. Our focus on innovation is reflected in our BlueBolt grassroots innovation initiative, which we launched a year ago in April. BlueBolt has already generated more than 130,000 ideas from our associates, 23,000 of which have been implemented with clients.
Overall, more than 220,000 Cognizant associates have been trained on BlueBolt. In addition, Google named Cognizant a Google Cloud 2024 breakthrough partner of the year. This is one of our industry’s most distinguished awards. I will elaborate more on Google Cloud in a moment. And just this month, LinkedIn recognized Cognizant as a number three on its top companies 2024 employer list in India, which is home to more than 250,000 of our valued associates. This repeat recognition is a reminder that our focus on becoming the employer of choice is paying off in the country that is at the heart of Cognizant success in India. These client wins and industry recognition demonstrate one of our core differentiators, our collaborative innovation. And nowhere else is the demand for innovation higher than in Gen AI.
To date, we have more than 450 early client engagements and more than 500 additional opportunities in the pipeline. We have seen increased demand for AI services across four key areas. First, customer and employee experience as clients seek to deliver improved interactions through hyper personalization. Second, content summarization insights to empower decision making. Third, content generation. And finally, leveraging GenAI to accelerate innovation and technology development cycles. We continue to see strong interest from clients as they assess proofs of concept and the return on investment of these opportunities. These efforts are supported by a recently launched advanced artificial intelligence lab in San Francisco where we are investing instead of the art core AI research, aim to position us at the forefront of innovation in our industry.
This builds upon our network of AI innovation studios in London, New York, San Francisco, Dallas and Bangalore. Incidentally, our advanced artificial intelligence lab has already produced 53 AI patents with applications for many more pending. This quarter alone, we had seven new AI patents approved and granted to us. In quarter one, we announced a series of new partnerships and co-innovations behind the strategy we announced last year to invest $1 billion in generative AI over three years. This includes our collaboration with Microsoft to infuse GenAI into healthcare administration. The TriZetto stand on a facets platform will leverage Azure Open AI service and semantic canal to provide access to GenAI within the TriZetto user interface. We are already progressing from proof-of-concept to the piloting phase and are seeing strong interest from some of our largest healthcare customers.
And last week, we announced another element of our expanded partnership with Microsoft. We plan to leverage Microsoft Co-Pilot and Cognizant’s advisory and digital transformation services to help our employees and enterprise customers operationalize GenAI and realize strategic business transformation benefits from this technology. In addition, as a part of Cognizant’s Synapse skilling program, Cognizant will train 25,000 developers of the use of GitHub Copilot, doubling the number trained on the technology. We are also collaborating with NVIDIA to leverage our deep life sciences and AI domain expertise with NVIDIA’s pre-trained industry-specific generative AI models offered as a part of by Nemo. Through this collaboration, we will provide clients access to a suite of model-making services, including pre-trained models, cutting-edge frameworks, and application programming interfaces that offer clients an accelerated path to train and customize enterprise models using the proprietary data.
By leveraging GenAI-infused models, clinical researchers can rapidly sift through extensive datasets, more accurately predict interactions between drug compounds and create a new viable drug development pathways. We also expanded our partnership with Google Cloud. We’ll adopt Gemini for Google Cloud in two ways. First, by training Cognizant associates to use Gemini for software development assistance, and second, by integrating Gemini’s advanced capabilities within Cognizant’s internal operations and platforms. Using Gemini for Google Cloud, Cognizant’s developers will be equipped to write, test, and deploy code faster and more effectively with the help of AI-powered tools, improving the reliability and cost efficiency of building and managing client applications.
Over the next 12 months, Cognizant expects to upscale more than 70,000 cross-functional associates on Google Cloud’s AI offerings. This is another milestone in our Synapse initiative to upscale 1 million individuals globally by 2026. Additionally, Cognizant will work to integrate Gemini into its suite of automated platforms and accelerators, beginning with the recently announced Cognizant Flow Source platform for developers. As a part of our social responsibility platform, we recently announced that since 2018, we have awarded $70 million in philanthropic funds to global scaling programs for underrepresented communities. These 117 grants combined Cognizant’s culture of continuous scaling are focused on prioritization on empowering diversity through technology and the philosophy that AI and other advanced technologies can be a great equalizer for the future of work.
We intend to continue following and participating in the AI innovation cycles by investing in last-minute platform infrastructure, productivity studies, and capabilities to enable better and faster integration into enterprise landscapes. In the last 12 months, our AI platforms gained significant traction as we onboarded clients onto Neuros, Skygrade, and Flowsource platforms to cover various phases of AI deployment cycles. By investing in productivity studies which dissect the anatomy of scales and occupations and map the AI exposure scores to different roles, we have assisted our clients in realizing value and driving the scaled embrace of newer AI use cases. As we continue to navigate this ongoing soft demand environment, we remain focused on investing in areas to help our clients reduce total cost of ownership, boost productivity, enhance technology intensity, and enable better adoption of new age technologies like AI to capture the current demand and be prepared for the future.
And we remain differentiated by investing in industry domain capabilities and platforms in select industries. We also believe in organic opportunities remain an important element of our investment strategy. We continue to seek, to expand and deepen capabilities, diversify our business, including into industries where we are underexposed and improve our geographic mix. For example, we are pleased with the early traction of our Q1 acquisition of Thirdera, an industry-leading ServiceNow platform which has significantly expanded our capabilities and credentials. We already see a healthy pipeline of opportunities as direct result of this acquisition to cross-sell within our existing client base. In closing, I want to thank our 345,000 employees around the world for the dedication to our clients and Cognizant.
In 2024, we will keep working to increase our revenue growth, become the employer of choice in our industry, and to simplify our operations. Jatin, over to you.
Jatin Dalal: Thank you Ravi and thank you all for joining us. As I enter my 6 months as Cognizant CFO, I remain deeply impressed by the culture, passion and client centricity across the organization. I am pleased with our execution in the first quarter in what remains a tough economic environment. Revenue exited the high end of our guidance range supported by our communication, media and technology segments. The sequential growth of our healthcare segment was also heartening. Strong execution on our next-gen program and disciplined cost optimization actions allowed us to deliver a 15.1% adjusted operating margin, representing 50 basis points of expansion year-on-year. Looking ahead, I am focused on several objectives in support of our broader strategic priorities.
First, continue to strengthen our partnerships and collaborations across the organization to improve revenue growth. Second, improve our margin profile through our next-gen cost programs and process enhancements, driven in part by leveraging AI tools. Next, continue to invest in our people with a focus on supporting our company-wide employee skilling programs designed to train our employee on the latest technology, including GenAI. And finally, drive disciplined execution with a focus on maximizing value creation from our M&A investments and improving our large-deal [ph] risk management framework. First quarter revenue was $4.8 billion, representing a decline of 1.1% year-over-year or a decline of 1.2% in constant currency. Year-over-year performance includes approximately 70 basis points of growth from recent acquisitions.
On a sequential basis, revenue was flat from the prior quarter. Across global industry segments and geographies, we have seen the uncertain economic outlook and volatile geopolitical environment way on our client-spending priorities, which has kept their discretionary span muted. These headwinds are more pronounced in financial services, which is more susceptible to higher interest rates. Health sciences customers are also being impacted by the inflationary environment and industry-specific headwinds. At the same time, clients continue to prioritize spending that can deliver cost savings quickly and continue to fund investments in transformation and innovation. For example, within our products and resources segment, we have seen resiliency among utility customers where greed modernization remains a critical priority.
This has been further supported by our 2022 acquisitions of Utegration, which helps drive SAP S/4 cloud opportunities with the utilities customers. In addition, we have seen positive trends amongst automotive customers in area like software-defined vehicles and in our Products and Resources segment where the convergence of IT and operational technology is driving transformation and digitization priorities. Finally, we were pleased with the performance of our Communications, Media and Technology segment, which grew year-over-year, driven by contribution of recently completed acquisitions and wins with the communications and media customers. This has helped offset discretionary spending pressure among our technology customers, which we believe have been impacted by clients focused on reducing costs.
Now moving on to margins. Our next-gen optimization program has progressed well in helping us drive structural cost savings and simplification of our operations. During the quarter, we incurred approximately $23 million of costs related to this program. This negatively impacted our GAAP operating margin by approximately 50 basis points. Excluding this impact, adjusted operating margin was 15.1%, which benefited from savings related to our NextGen program and the depreciation of the Indian rupee. Both our GAAP and adjusted tax rate in the quarter were 24.8%. Q1 diluted GAAP EPS was $1.10 and Q1 adjusted EPS was $1.12. Now turning to cash flow and the balance sheet. DSO of 78 days was up 1 day sequentially and increased 5 days year-over-year, primarily driven by our business mix.
Free cash flow in Q1 was $16 million and included the impact of previously disclosed $360 million payments made to Indian tax authorities as well as the payout of bonuses that were accrued last year. As a reminder, the tax payment to the Indian tax authority was required to proceed with the appeals process relating to our 2016 tax matter. The appeal is ongoing and final amounts refunded to Cognizant or due to tax authorities will be determined at the end of the process. We also returned $284 million to shareholders, including $133 million through share repurchases and $151 million through our regular dividends. In addition, we completed our acquisition of Thirdera in January for a total consideration net of cash acquired of approximately $420 million.
These factors drove quarter end cash and short-term investments of $2.2 billion or net cash of $1.6 billion. In 2024, we continue to expect to return over $1 billion to our shareholders, including at least $400 million through share repurchases and $600 million through regular dividends. We will also continue to evaluate inorganic strategic investment opportunities to help accelerate our growth profile, expand our capabilities and diversify our portfolio. Now let me speak about the forward outlook. For the second quarter, we expect revenue to be flat to growth of 1.5% sequentially, in constant currency. Year-over-year, this implies a decline of 2.5% to a decline of 1% in constant currency. On a reported basis, this translates to a revenue of $4.75 billion to $4.82 billion, representing a year-over-year decline of 2.9% to a decline of 1.4%.
For the full year, we continue to expect a revenue decline of 2% to a growth of 2% in constant currency. On a reported basis, this translates to revenue in range of $18.9 billion to $19.7 billion and a decline of 2.2% to a growth of 1.8%, reflecting our latest exchange assumptions. The guidance we are providing of today assumes up to 100 basis points inorganic contribution. We see an active pipeline of acquisition opportunities, and we continue to evaluate assets for the right capabilities to support our strategic priorities. Our NextGen program remains on track, and there are no changes to our assumptions regarding the program. We still intend to reinvest the majority of NextGen savings in our growth opportunities in 2024 and beyond. Moving on to adjusted operating margin.
We are pleased with our Q1 performance and we continue to expect the full year to be in the range of 15.3% to 15.5%. For Q2, we expect adjusted operating margin will be in a narrow range around Q1s number with NextGen cost savings and improved utilization being offset by initial negative impact from the ramp of large deals and the revenue mix. I am pleased with our sequential improvement in utilization during the quarter, and we are sharply focused on driving further improvements to support margins next quarter. For the full year, we anticipate net interest income of approximately $60 million, which compares to $40 million previously, primarily reflecting updated interest rate and cash balances assumptions. Our adjusted tax rate guidance of 24% to 25% remains unchanged.
Our full year free cash flow guidance is also unchanged, and we continue to do expect it will represent 80% of our net income. This includes the previously discussed negative impact of $360 million payment made with Indian tax authorities in relation to our ongoing appeal of our 2006 tax method. Our guidance for shares outstanding is unchanged at approximately $497 million. This leads to our full year adjusted earnings per share guidance of $4.50 to $4.68, unchanged from our previous guidance. With that, we’ll open the call for your questions.
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