Cognizant Technology Solutions Corp (CTSH) — Q2 2022 Transcript

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 2022 results. If you have not, copies are available on our website, cognizant.com. The speakers we have on today's call are Brian Humphries, 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 or 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 Brian Humphries. Please go ahead, Brian.

Thank you, Tyler. Good afternoon, everyone. I'd like to comment on several topics today, notably our second quarter performance, the demand and pricing environment, and labor market dynamics. Let's start with our second quarter performance, which was balanced. Second quarter revenue was $4.9 billion, up 9.5% year-over-year in constant currency. Growth was led by digital. Second quarter operating margin was 15.5%, up 50 basis points sequentially, in line with our expectations. Financial leverage driven by sequential revenue growth, disciplined expense management, currency benefits, and the optimization of the pyramid, shoring, and fulfillment helped offset the impact of attrition and labor cost inflationary pressure. Our industry segment performance remained largely consistent. Financial Services grew 5.1% year-over-year in constant currency, led by insurance growth. This includes a negative impact of 190 basis points from the exit of Samlink. We continue to make progress strengthening client relationships in Financial Services. Earlier in the second quarter, I visited clients in Germany and celebrated a new logo win with Zurich Insurance Germany. Cognizant will help them simplify, modernize, and manage their enterprise application landscape by establishing joint DevOps teams and working to extend the insurer's AI, data, software engineering, and cloud capabilities. In insurance, CCC Intelligent Solutions whose SaaS platform powers the property and casualty insurance industry, asked for our help in enabling their cloud transformation program. We led with our enterprise DevOps and cloud transformation consultancy and partnered with Microsoft to present a comprehensive solution. This prompted the client to also select us to build next-generation analytics and telematics solutions that are expected to be key to their long-term leadership. In the second quarter, we combined our Healthcare and Life Sciences operating segments into a single operating segment called Health Sciences and naturally dilution, given the market conversions across these industries. Health Sciences grew 7.6% year-over-year in constant currency, with growth driven by pharmaceutical clients and sustained momentum in our TriZetto product portfolio. Commonwealth Care Alliance, an integrated care system serving over 60,000 members across numerous U.S. states, illustrates our momentum in TriZetto. Our end-to-end business process innovation powered by TriZetto solutions and a BPaaS engagement is fully integrated from enrollment and billing through claims. Through our partnership, Commonwealth Care now has the tools needed to compete in the digital health ecosystem and support value-based personalized care for its members. We've also signed a new multiyear agreement with Organon, a global women's health company to help improve the delivery of healthcare products and crucial medicinal supply chain management. We'll help Organon scale its healthcare business by delivering full-stack industrial technology support for its global pharmaceutical manufacturing sites in the UK, Netherlands, Belgium, and Indonesia. We continue to see excellent growth in Products and Resources, where revenue grew 11.6% year-over-year in constant currency, driven in part by strength among automotive, logistics, retail, and consumer goods clients. As a strategic partner for digital, we're helping Albertsons Companies, a $70 billion grocery retailer, make their move to a cloud-based infrastructure model, enabling innovation and improved customer experiences, both in-store and across last-mile delivery. In Communications, Media and Technology, we had another quarter of excellent growth. Revenue grew 19.5% year-over-year in constant currency driven by technology clients and new client acquisition. DocuSign is an example of a new logo win. They selected Cognizant as the preferred partner for global customer support operations across all products and services from their flagship e-signature product to newer contract lifecycle management products. DocuSign turned to us because of the distinctive solution proposed by our intuitive operations and automation practice, including cutting-edge omnichannel customer support and outcome-based commercial models. A quick word on our recently announced organizational evolution. In July, we announced the combination of our practice areas with delivery practices, which simplifies our model by bringing Cognizant in line with industry norms. This enables us to have end-to-end accountability across 4 integrated practices from vision, roadmap offerings and capabilities, including M&A and post-merger integration through to presale solutioning and delivery. I believe this will assist our industry teams to be more successful with our clients as we sell solutions and deliver client outcomes. I also believe that our industry capabilities provide differentiation that we can unlock value for clients at the intersection of industry use cases and technology. Moving now to the demand and pricing environment. While we are carefully monitoring the potential impact of a worsening economy in our pipeline, to date, we've not seen any significant slowdown for IT services demand. That said, as we serve some of the largest clients in the world, we are aware that should they see slowing earnings growth, nonessential projects or those with longer ROI may be paused. I am confident that the breadth of our portfolio enables us to serve our clients' needs for higher levels of agility, innovation, resilience, and indeed, efficiency. So regardless of what the coming quarters bring, our value proposition to clients remains. More generally, digital transformation has become so essential and foundational to most companies, regardless of their industry, that despite some macro demand uncertainty in the short term, I remain optimistic on IT services' growth prospects in the medium to long term. In fact, the bigger challenges we are faced with as an industry are the demand supply and balance on key digital skills, elevated attrition, and labor cost inflationary pressure. I would like to thank our associates around the world who've been working hard to navigate these challenges, all whilst trying to optimize fulfillment and pricing. Achieving the perfect balance is not always easy. And in the second quarter, while I'm pleased that we drove both year-over-year and sequential margin expansion, I suspect that our focus on fulfillment optimization and pricing marginally impacted top-line performance and hurt bookings momentum. Second quarter bookings declined 3% year-over-year, below our assumptions entering the quarter. While we continue to have a robust book-to-bill ratio of approximately 1.2x revenue on a trailing 12-month basis, by better balancing the factors just mentioned, we aim to accelerate bookings growth in other quarters, whilst nonetheless achieving our committed margin expansion. Just a word now on pricing. Market pricing dynamics remain consistent. Clients, through their vendor exposure and their internal teams, are privy to demand supply and balances across key digital skills and labor cost inflationary pressure. This, coupled with the pent-up demand for digital transformation, means clients are more predisposed to engage in price increase discussions. Clients are willing to pay for skills and innovation, with efficiencies, including automation and optimized delivery mix, are expected to mitigate cost increases. We continue to execute against a pricing initiative to offset labor cost inflationary pressure, with benefits starting to be felt, but greater impact expected in the coming quarters, recognizing that pricing power stemming from talent shortages will lag behind talent-related cost increases. Let's move now to labor market dynamics, including attrition and inflationary pressure. Second quarter voluntary attrition rose 5 points to 31% on an annualized basis or 32% on a trailing 12-month basis. This increase was slightly above the seasonal uptick we anticipated entering the quarter, impacting second quarter revenue performance. While we have seen some signs of improvement in July resignation rates, we continue to expect elevated attrition for the remainder of the year. As I've mentioned on prior calls, attracting, retaining, and rallying our talented employees is one of our top priorities. In the past year, we've invested record levels in compensation, overhauled our promotion process, invested heavily in our learning and development initiatives, and introduced a series of other measures, including educational programs and returnships. Our internal job moves program, which facilitates ongoing upward mobility in the company, is one factor that enables us to mitigate the need for and deepen the cost pressure of lateral hires, all whilst improving morale. We've also recognized how important flexibility is to our associates and have, therefore, communicated a hybrid model that will define our approach to work. Our priority is to be a welcoming, inclusive, and equitable company for everyone, no matter their work location. Our clients and associate-centric company aims to strike a balance between how clients want to interact with us and the flexibility we seek, all while maintaining a focus on employee engagement, collaboration, our values, and a culture of continuous learning. I'm pleased to see that our efforts on employee engagement are working. In recent weeks, we completed our annual engagement survey that showed significant increases in our engagement scores, positioning us above industry benchmarks. In closing, as we execute our strategy, we are operating with 3 clear priorities: first, execute our vision to become the preeminent technology services partner to the Global 2000 C-suite; second, rally and engage our associates around the world; and third, drive profitable growth. Despite some near-term macro demand uncertainty and the challenges of navigating today's labor markets, let's not forget that we are at the early stages of what we expect to be a massive digital build-out. Thanks to our portfolio and our talented employees around the world, we believe that we will be a strategic beneficiary as companies embrace digital operating models. Finally, as we reposition Cognizant towards selling, solutioning, and delivering industry-aligned solutions, enabled by targeted advisory capabilities, our margin potential will be strengthened in line with our brand repositioning to higher-value services. With that, I'll turn the call over to Jan, who will cover the details of the quarter and our financial outlook before we take your questions. Jan, over to you.

Thank you, Brian, and good afternoon, everyone. While our Q2 revenue growth was slightly below the midpoint of our guidance range, we delivered sequential margin expansion in line with our expectations, while continuing to invest in our talented people. We remain focused on profitable revenue growth. Moving on to results. Q2 revenue was $4.9 billion, representing an increase of 7% year-over-year or 9.5% at constant currency. Year-over-year growth includes approximately 110 basis points of growth from our recent acquisitions and a negative 60 basis points impact from the sale of Samlink completed February 1. In Q2, digital revenue, as reported, grew 13% year-over-year and included FX headwinds of approximately 250 basis points, consistent with the total company. At quarter end, digital represented approximately 50% of total revenue, up 3 points from the prior year period. In addition to the FX headwinds, the slowing of digital growth reflected lower inorganic contribution and elevated attrition, in particular, in North America. Despite these headwinds, we were pleased with the growth across our digital battlegrounds, which outpaced the total digital growth. As Brian mentioned, Q2 bookings declined 3% year-over-year. This resulted in trailing 12 months bookings of $23.2 billion, which represented a book-to-bill of approximately 1.2, unchanged from Q1. Despite the softer-than-expected growth, we continue to believe this book-to-bill provides us a healthy opportunity to support our revenue growth outlook for 2022. We expect to improve bookings growth in the quarters ahead. Moving on to segment results for the second quarter, where all growth rates provided will be year-over-year in constant currency. Financial Services revenue increased approximately 5%. Q2 growth included a negative 190 basis points impact from the sale of our Samlink subsidiary. Our recovery within financial services remains largely in line with our expectation, driven by continued strength in our North America regional banking portfolio, growth in the UK, and steady performance within insurance globally. Health Sciences revenue increased approximately 8%, driven by demand for digital services among pharmaceutical companies. Demand among healthcare clients was consistent with last quarter. Momentum continued in our integrated software solutions. Products and Resources revenue increased approximately 12%, driven by growth across all segments and included approximately 260 basis points contribution from recently completed acquisitions. This compares to the approximately 500 basis points contribution we reported in Q1 of this year. Based on the current portfolio of closed acquisitions, we expect the inorganic contribution to be immaterial to segment performance beginning in Q3. Communications, Media & Technology, or CMT, revenue grew approximately 20%, primarily organically, including growth from new clients. This reflects growing demand for data services and our work with leading digital native clients. We also continue to experience strong demand for our intuitive operations and automation services, which includes our BPO business. From a geographic perspective in Q2, North America revenue grew 9% year-over-year. Growth was led by CMT and Life Sciences clients. Our global growth markets, which includes all revenue outside of North America, grew approximately 12% year-over-year in constant currency, which included a negative 240 basis points impact from the sale of Samlink. Growth was led again by the UK, which grew 25% and included strong double-digit growth within financial services, including the public sector, science, Products and Resources, and CMT. We continue to see significant opportunities for growth in our GGM business and do not believe that we are hitting our full potential yet. Now moving on to margins. In Q2, our GAAP and adjusted operating margins were 15.5%, as there were no non-GAAP adjustments in the quarter. On a year-over-year basis, operating margin increased by approximately 30 basis points, in line with our expectations. This included improvement in gross margin, driven in part by a balanced execution and our focus on profitable revenue growth. We also experienced a benefit from the depreciation of the rupee against the dollar and a modest benefit from our recent pricing initiatives. Additionally, we were pleased with the SG&A leverage we drove in the quarter. Our GAAP tax rate in the quarter was 24.2%, and the adjusted tax rate in the quarter was 22.2%, which benefited from a discrete tax benefit related to our unrepatriated accumulated foreign earnings, driven by the depreciation of the rupee. Q2 Diluted GAAP EPS was $1.11, and Q2 adjusted EPS was $1.14, up 14% and 18% year-over-year, respectively. Now turning to the balance sheet. We ended the quarter with cash and short-term investments of $2.3 billion or net cash of $1.7 billion. Free cash flow in Q2 was $485 million, representing approximately 84% of net income, in line with our expectation. This brings year-to-date free cash flow to $671 million. DSO of 74 days increased by 2 days sequentially, driven in part by seasonality and by 3 days year-over-year. We expect to improve DSO in the second half of the year. During the quarter, we repurchased 4 million shares for $300 million under our share repurchase program and returned $141 million to shareholders through our regular dividend. This brings total capital return to shareholders through share repurchases and dividends to over $1 billion through the first half of 2022. Turning to guidance. Our outlook for the remainder of the year assumes that we will continue to balance margin performance and revenue growth. For Q3, we expect revenue in the range of $4.98 billion to $5.03 billion, representing year-over-year growth of 5% to 6% or 7.5% to 8.5% in constant currency. Our guidance assumes currency will have a negative 250 basis points impact as well as an inorganic contribution of approximately 50 basis points, which reflects the lower-than-anticipated M&A activity compared with our assumptions in prior full-year guidance. For the full year, we are lowering the midpoint of our constant currency revenue growth guidance by about 1 point, which reflects, in part, the impact we have had while navigating the current industry supply-demand imbalances, elevated attrition, and softer-than-expected hiring, particularly in North America. However, we are maintaining our margin expansion guidance, which reflects the prioritization of profitable growth, pricing initiatives, and the rigor that we have put around SG&A. Our full year revenue, we still expect inorganic growth to contribute approximately 100 basis points to growth, unchanged from prior guidance. This assumes an immaterial contribution from future unannounced acquisitions in Q4. Our reported revenue outlook now assumes a negative 220 basis points impact from currency versus 180 basis points previously. This leads to a revised reported revenue guidance in the range of $19.7 billion to $19.9 billion, representing 6.3% to 7.3% growth or 8.5% to 9.5% growth in constant currency. This compares to our prior guidance of $19.8 billion to $20.2 billion, which represented growth of 7.2% to 9.2% or 9% to 11% in constant currency. Our longer-term capital allocation framework is unchanged. Today's uncertain macroeconomic backdrop has the potential to create a mismatch of valuation expectations between buyers and sellers as well as challenging synergy assumptions. Despite these dynamics, our pipeline remains active, and we expect to announce deals towards the end of this year. However, these factors have led us to deploy less capital than anticipated on M&A. Therefore, we are revising our capital allocation plans for the remainder of 2022. We now expect to return at least $1.2 billion through share repurchases for the full year, up from our commitment of at least $600 million last quarter. As always, this remains subject to market conditions and other factors. Given the strength of our balance sheet and expected free cash flow generation, we do not expect liquidity will restrict our ability to execute against our M&A pipeline for the remainder of the year. As I mentioned earlier, our adjusted operating margin outlook is unchanged, and we continue to expect approximately 20 basis points to 30 basis points of expansion versus 2021. Our outlook for operating margins continues to assume industry supply-side constraints, elevated attrition for the remainder of the year. Headwinds to operating margins include increased compensation costs, C&E, and return-to-office costs, which we expect to offset through delivery efficiencies, digital revenue mix, pricing, and SG&A leverage and discipline. Our guidance assumes continued sequential margin expansion in Q3 before the impact of our annual merit cycle in Q4. Our full year outlook assumes interest income of approximately $35 million versus $25 million previously, reflecting higher interest rates. Based on our increased share repurchase activity, we now expect average shares outstanding of approximately 519 million versus 522 million shares previously. We also now expect a tax rate of 24% to 25% versus 25% to 26%, reflecting lower year-to-date performance. This leads to our full year adjusted EPS guidance of $4.51 to $4.57, up approximately 9% to 11% year-over-year. This compares to $4.45 to $4.55 previously. Finally, we are still targeting full year free cash flow conversion of approximately 100% of net income. With that, we will open the call for your questions.

On the revenue progress and outlook, you've provided some updates here for us. How much of the revenue challenge versus the plan that you had 3 months ago and even earlier this year, how much of that is due to supply challenges? It sounds like a lot of it is supply versus macro challenges that are being faced within your client base and potential that the macro challenges are starting to ramp up.

Rod, it's Brian here. Thanks for the question. Look, it's very much related to more towards the demand-supply and balance that we see in the market. We gave guidance in November around the revenue target range of 8 to 11 over the coming years with about 2 points from M&A. Today, we reported 9.5 points of growth, so within that range. And even the guidance we gave is within that range. But my hope obviously is that with better demand-supply situation Cognizant would have better headcount and be better able to get after the revenue opportunity, whilst also I feel pretty good about where we are on margin these days. So really for us now is about continuing to evolve the business portfolio to higher growth categories, making sure we get the headcount right, both in terms of increasing retention and making sure we even get better throughput in terms of our recruitment. And then, of course, targeted M&A, which tends to be accretive to our revenue CAGR, some targeted larger deals that may or may not come ultimately in the years to come. But we'll be selective on those, as I've always said. And in some regards, today's margin profile, I think, is also indicative of the fact that in recent years, we haven't made big bets that may have been wrong in terms of attrition assumptions or margin or cost assumptions. So it's really about those things, Rod. Macro, we've seen some impact in terms of pipeline progression but it's been more modest. We haven't seen anything meaningful in terms of a slowdown in demand, and I'm still certainly of the opinion that while we'll have to keep an eye on the earnings cycle of our major clients and understand how they think about larger projects or ERP rollouts or projects with ROI timelines. At the end of the day, I'm very optimistic about IT services growth prospects in the medium to long term, and we'll continue to shape the portfolio to make sure we are able to show up and add value to clients.

Okay. Well, that's helpful. That demand is not being significantly impacted, it sounds like by macro. On pricing, you made some comments on pricing. And just to follow up on that, are you feeling that your pricing progress is consistent with the expectations that you had 3 and 6 months ago? Or is the macro factors also creating more challenges in getting prices realized?

Yes. Rod, I'll jump in. The pricing environment, we would still overall characterize as consistent, and we feel we do have pricing opportunities for us that we are realizing and working hard to achieve. We see better opportunities in our digital opportunities where the demand is really difficult to supply and value is high, our new digital-type services as we see better opportunities. We talked in the last quarter about our initiatives to drive pricing across our entire client portfolio. And we're making progress. We always anticipated that this would be a multi-quarter endeavor. Some of these negotiations are ongoing, but we do see early results, and that's why I mentioned in my commentary that we do see some modest contribution from pricing, not only to margin, but obviously, to our overall margin development.

Just wanted to switch over to bookings. I know you mentioned they were below your expectations for the quarter. Wondering if you can quantify the shortfall there? And maybe just talk about what you think some of the root causes might have been. Obviously, they can be lumpy quarter-to-quarter, but I'm guessing that the bookings are kind of less affected by the supply-demand imbalances that you just talked about as it relates to revenue. So I would just like to get a little bit more color there? And do we start to see improvement in the bookings growth trajectory in Q3?

Jason, it's Brian. So you said it right, bookings can be choppy, which is why I've always been an advocate of looking at bookings on a rolling 12-month basis. So on a trailing 12-month basis, our bookings are still quite strong with a book-to-bill of 1.2. But within any given quarter, you'll have dynamics at play. And this was a quarter where we knew we had to go focus on resource fulfillment, given where we were from an attrition and resource point of view, but also we wanted to make sure, given labor inflationary trends, we were able to address pricing discussions with clients. And that may have had even a psychological impact on our commercial team as they are focused on fulfillment and focused on pricing discussions, and perhaps concerned about selling the next thing if they're worried about being able to fulfill against it. So it's not quite as clean as you suggested. But fundamentally, we'd expect this to pick up in Q3 and Q4. Demand is there to the question that Rod asked earlier. We feel pretty good about our portfolio these days. We are repositioning the brand and repositioning how Cognizant shows up to clients and the kind of work we want to engage in. So it's maybe a question of balance. That's perhaps the word of this quarter's earnings. We're very proud that we're an outlier in the industry in the sense that we were able to drive margin expansion year-over-year and quarter-over-quarter. We obviously want to accompany that with revenue growth and bookings momentum, and that's what we're setting out to achieve, obviously, on a go-forward basis.

And then just on the supply side, is attrition or is hiring the bigger challenge right now? And do you think Q2 will, more or less, be the peak on attrition? I know you said you expect it to remain elevated, but just wondering what other actions the company might take to improve that metric?

We've taken significant actions from an attrition point of view, both in terms of compensation, significant investments in career path and overall our promotion process, significant investments in learning and development, and then in a whole host of other activities around education, returnships, and whatnot. I will say there are some opportunities here that we have. This is seasonally in line with, I guess, expectations, although it was a little above what we had assumed going into the quarter. But we are somewhat confident that the actions we're taking are really kicking in. Employee engagement, as I suggested in my prepared remarks showed increases year-over-year across all 8 categories that we measured and were above industry benchmarks by the way. We have seen progress in terms of the actions we've been taking in the last 18 months. It has really improved our relative compensation position across key markets, including India. And while it's only 1 month of the quarter, the resignation trends we've seen in July, which isn't just about Q3, it's also about Q4, have been improving. And we have good success on this internal job moves program, which is creating a much more dynamic promotion process. So those are good leading indicators, I'd say, in terms of retention. On the recruitment side, I think it's fair to say the industry has been faced with almost its musical chair situation, where people show up with multiple job offers. The macro dynamics may actually start becoming more favorable. Early indications are that offer to join, our ratios have recovered a little bit in recent weeks, and I dare say, for us, perhaps for others as well. So we're looking forward to hopefully being able to build our headcount more aggressively on a go-forward basis and therefore, be able to achieve our true top line potential on the back of increased operational rigor and margin discipline that we've established.

I know Jason asked about your confidence or visibility on bookings improving. But just thinking about your headcount changes a little bit here, it did slow down quite a bit sequentially after a period of strength. So just trying to read into that as I'm assuming you're just going to focus a little bit more on utilization here at this point of the cycle? Just trying to reconcile those two things.

Yes. Maybe just as a quick reminder, our second quarter is typically a higher attrition quarter that has to do with some of the bonus payments that we issue at the end of March. So we knew that we would have increased attrition that we don't expect to continue throughout the year. So that's number one. It did turn out to be a little bit higher, maybe also for the revenue impact that we identified, it did tick up a little bit higher and a little bit more impact in North America than the core of our operation in India. So from a medium-term perspective, I would think we still have elevated attrition levels, although not at the level that we have seen in the second quarter.

The other thing I'd just add to that as well is, of course, all headcount is not the same. We've seen a shift of our delivery to offshore in the last few years. And I think where we have to put a little bit more effort in place is to continue to build our onshore headcount, particularly in North America. We've gone through a pretty extensive effort in the last 3 years to reduce visa dependency in North America. But hand in glove with that, we have to continue to scale campus hiring, lateral hires, and obviously, headcounts in North America, while maybe having a lower margin rate can actually give us more dollars per head on both revenue and indeed gross margin. So that's an important factor as well. But yes, we're all over this, and you can imagine it's got our full attention, both in terms of the recruitment throughput, offer-joiner ratios that we track as well as what we're doing from a retention point of view. Obviously, the employee satisfaction and employee engagement survey results were very pleasing to see. So it's good to see the progress we're making.

Just quickly on for my follow-up, the 1.2 book-to-bill being stable. I heard that. But is there a way to look at annualized backlog as well or some other metric thinking about that trend, assuming that there's some short-term project work and maybe some of the bookings have converted? Just on duration or ACV is another metric. I know you don't give it, but any interesting calculations there.

We don't really get into those details, but our average contract duration actually increased quarter-over-quarter and year-over-year. Some of that is because we had a little bit more momentum in larger deals, and some of it is because of the situation that in a resource-constrained environment, we were quite selective in terms of the deals that we get after with a view to ultimately aligning our resources in line with our business model evolution. And that business model evolution is around aligning resources to our targeted customer segments, aligned to selling, solutioning, and delivering client outcomes as opposed to simply being a provider of resources for clients. And if you're simply a provider of resources for clients, you can skew to lower-end deals and being in the mode of staff augmentation. So our strategy informs our actions. And this quarter, obviously, with the cards we had, which was a resource-constrained environment, we obviously had the luxury of being able to make choice points that were both beneficial to our strategic direction as well as beneficial to our margins.

I wanted to ask about the competitive environment. It appears that your balance strategy is different from what we’ve observed from some of your peers in their early reporting, particularly regarding share and margin dynamics. Could you provide some insight into your thinking behind this balance strategy? What drives your perspective on its appropriateness and how do you envision it developing from here?

I’ll begin. Jan, feel free to add your thoughts if you’d like. Ultimately, we should return to the multiyear framework we presented in November during Analyst Day, where we discussed our aspirations for revenue growth and margin expansion over several years. I believe this perspective remains valid for Cognizant. Nothing has fundamentally changed. The results we've shared this quarter show a 9.5% growth in constant currency, along with notable year-over-year and quarter-over-quarter margin expansion, which sets us apart from the rest of the industry. This aligns with our expectations moving forward. The more resources we have, the more aggressively we can pursue top-line growth. However, our primary focus has been on establishing strong operational discipline regarding pricing, service mix, and delivery structure, which is a long-term initiative. We’ve also made investments in the company that are beginning to pay off. As we achieve sequential growth, we realize more financial leverage. So, our outlook remains consistent with what we shared in November, and that’s how you should view us going ahead. As we improve our retention trends, we hope to have the opportunity to accelerate growth and enhance our balance compared to this quarter.

Yes. And maybe I'll add the component of the business mix that we have been adding in our growth. We have gotten these questions in past calls. We have been absent from large and mega deals in the past, and in the last couple of years. And arguably, that had slowed our revenue growth, but it allowed us to much better control our balanced portfolio of the revenue growth within the corridors that we outlined, plus the margin expansion, which is just our fundamental belief that will build the compounding, the most quality type business over time.

Can you provide some insight into how you've formulated your outlook, particularly regarding the key components like pricing, attrition, wage inflation, and the macroeconomic environment? Which of these aspects do you anticipate will improve in the second half of the year, which ones do you expect to remain steady, and are there any that you foresee deteriorating?

Yes, I believe we are on track year-to-date with what we had expected for the year. One area we aim to improve is our bookings growth, along with reducing employee attrition. These two factors will enable us to accelerate revenue growth within our outlined framework and meet our bottom-line commitments. We see opportunities for focused improvements that are not broadly enterprise-wide. For instance, I highlighted the situation in North America, where we plan to enhance our staffing to positively impact revenue and strengthen our position. We will also encourage revenue growth and bookings through our distribution and sales capabilities. Overall, the company is in good shape; we are managing our SG&A effectively, which allows us to maintain our margin balance. Additionally, shifting towards a digital mix is benefiting our overall gross margin, and our continued pricing actions will support top-line growth and the sustainability of our margin profile. We have established a solid foundation and are now focusing on specific areas for improvement for the rest of the year.

With financial services being your largest vertical, you drilled down into demand trends in financial services in the second quarter across your range of services, digital versus legacy and how you expect demand to evolve in this industry segment in the balance of the year?

Yes, David, it's Brian. I would say there are no major concerns regarding demand in the financial services sector, particularly in banking. We had a strong quarter in commercial banking, outperforming retail, cards and payments, and capital markets. What we are observing is a more selective approach from Cognizant as we have redefined our positioning with larger banks, moving away from staff augmentation towards their transformation programs and innovation agendas. It's been an evolution in how we present our teams to clients and the solutions we aim to deliver, while also helping clients to view Cognizant in a new light. However, I do not see any fundamental macro issues in the banking sector. We also performed well in the insurance segment during the quarter, primarily in the United States, and I would describe that quarter as reasonably strong as well, with no significant macro concerns there either.

Maybe I'll just add some obvious things. Keep in mind that the reported results still reflect the impact of our disposition of Samlink, that is about a 200 basis points impact on the growth rate. In substantiation of Brian's comments, we do see, for example, digital revenue and revenue shares catching up to our company average and making progress on that mix. Brian gave you the cut by our sectors; we have also regional success, our regional banking portfolio, for example, continues to perform really with nice growth rates. And from that perspective, we see that continued what we call it a moderated improvement throughout the year to continue.

Appreciate that. And just as a follow-up, what action steps do you need to take to win more transformation business from the bigger banks? Do you need to add more in the way of management consulting capability? What are the key pieces you're focused on?

Yes, we've definitely been strengthening our consultancy business, but also, I would say more broadly than Cognizant Consulting, we've been trying to make sure that our client-facing teams holistically are more consultative. And that's a separate point, but nonetheless, similar in terms of the end product. And in parallel, I've personally been spending a lot of time on the road in the last 3 months in front of the C-suite of some of the larger banks, many of whom we haven't been able to serve in recent years and trying to make sure we have the opportunity to show up and be on their preferred vendor lists and evidencing to them the progress we've made with our portfolio and our strategic direction and how we think we can help them be successful in their own rights. So a little bit has been hunting. And then for those that we currently have, it's obviously been farming and making sure we have the right engagement teams, more advisory capacity, to your point, and then obviously educating clients who think of us differently as well. We're making progress. I think it's a paced recovery. It's ongoing, and we've continued to articulate that this business will likely grow slower than the company average rate, but yet we are confident we're doing the right things to get it in the right space.

I was hoping you could provide more details on the current M&A environment and the reasons behind the slowdown in your pipeline this year, considering the tightening macro conditions and the private markets. I expected it might actually become more active. Can you share what you are observing and why there has been a decline?

Absolutely, Lisa, I appreciate your question. It's essential for us to emphasize that our overall strategic approach to capital allocation remains consistent. We continue to view mergers and acquisitions as a vital tool for enhancing our company's competitiveness. The current slowdown in M&A activity is simply related to operational timing and the development of pipelines for pursuing deals. This situation also reflects our disciplined approach, as we conveyed in our prepared remarks. We are carefully considering how to allocate our capital in this uncertain environment, especially given the high valuation expectations that have been prevalent. It’s common for sellers to have higher expectations than what buyers are willing to meet, as we see things from different perspectives. We recognize this as we evaluate the rationale for M&A expenses. Overall, we remain positive about pursuing some M&A activities in the latter half of the year. We have an active pipeline, but closing transactions will depend on reaching mutual agreements, which can be impacted by the current economic conditions and varying expectations from buyers.

Got it. Okay. And then for my follow-up, I apologize for asking yet another question about this topic. But just a clarification on the supply fulfillment challenges that you mentioned have affected your revenue outlook for the year. You're just looking at your utilization numbers; they're running fairly steady, I guess, not seeing that they're running really hot. So can you just clarify, like is this like a skills issue? Or just maybe give a little bit more elaboration on what causes that sort of supply-demand imbalance, given that the utilization numbers are still kind of running at more normal levels?

Yes, Lisa, to clarify, our revenue performance was significantly below our expectations. We are currently refining our understanding of what occurred this quarter. Your observation about our consistent utilization over the past few quarters is correct. However, we are experiencing some overlapping impacts. For instance, our utilization has been negatively affected by the increased intake of recent college graduates. These new hires typically require time to reach full productivity, which impacts our overall utilization metrics, especially since we have other specialized skill sets that have resulted in high utilization and potential lost revenue. This is particularly evident in North America, where we are facing gaps in capacity for service delivery. Consequently, this localized effect is creating a balance that has led to missed revenue opportunities.

First one I got is on bookings. So I'm just trying to understand, are you experiencing pricing pushback and resourcing challenges that are causing more so delays or missed opportunities entirely? So I'm trying to get out really whether this is deal cycle extension or competitive loss and cancellation entirely there? And just how are you expecting fiscal '22 bookings growth to land now?

Bryan, it's Brian. We'd expect an acceleration in the second half of the year. The book-to-bill ratio remains healthy, as I said, at 1.2, really on the back of Q3 and Q4 last year, where bookings grew by 20% plus in both quarters. Look, some of this is frankly us in a resource-constrained environment given our headcount opted out of certain lower-end or less strategic opportunities. And so that's business that we decided not to partake in because we chose to prioritize our resources for elements of our portfolio that are more strategic to our future direction. And clients that are more strategic from a customer segmentation point of view. So that's the first point. The second point I would say is we did see during the course of the quarter, I would say, pipeline progression be a little slower than prior quarters and some pushouts into outer quarter periods, higher levels than traditional. I don't think it's enough to signify by any means and concern from a macro demand point of view because bluntly, the biggest single factor we have is just making sure we get fulfillment right, as opposed to worrying about the macro environment. We see plenty of opportunity for the clients I see. And frankly, I've probably visited a few hundred clients in the last quarter alone. So it's much more around our fulfillment capabilities and about the choice points we are faced with and that we take in a resource-constrained environment. As I said earlier, the average contract duration is a little bigger because we stepped away from some lower-end staff augmentation deals, and we've had a little bit more success in the $50 million-plus category. So that's the dynamics I would articulate.

Okay. And then just on margin. Maybe can you quantify or just talk about some of the larger underlying swing factors in the second half assumptions that you have? And I see in 2Q absolute dollar level of SG&A spend was roughly flat year-over-year despite the higher revenue base. So maybe can you talk about where exactly you're leveraging this? And to the tune of are you cutting more so around corporate? Or are you also throttling sales and marketing-related spend as well?

The margin performance in the first half has been influenced by multiple factors, and I expect this trend to continue throughout the year. Pricing made a modest contribution, and our pricing initiatives should enhance this aspect further. We have also observed positive impacts from the strategic measures discussed by Brian, including delivery pyramid optimization. These factors, along with the increased hiring of college graduates and careful management of subcontractors, have helped alleviate some of the compensation pressures we are experiencing and will continue to face this year. We noted a slight growth in SG&A, around 3% quarter-over-quarter. Funding the growth needed for our company remains a priority, and SG&A will not hinder our investment in growth. We are making progress in other corporate functions to improve efficiency and streamline operations. It's about managing multiple factors and determining how to react to quarterly results to achieve the best outcome. Typically, the third quarter is our highest margin quarter, so we anticipate a sequential increase in margin then. However, in the fourth quarter, we expect pressure due to our significant compensation measures for the delivery organization, but we remain committed to meeting our full-year guidance.

I just want to touch upon the other question around the commercial team. Now we're absolutely committed to the commercial team. The multiyear guidance that we gave in our November Analyst Day, that became part of the 2022 revenue guidance is really about participating in growth markets, orienting the portfolio to our higher-growth categories, and making sure we have world-class client-facing teams that are consultative in nature and that are productive in nature. And as many of you know, we've really built out a strong sales operations function here in recent years. We started showcasing to you the bookings position we have. We changed our variable compensation program for our commercial team and with a few years of data that we continue to hone in on opportunities around commercial productivity. But I would say the sales roster or the commercial roster is fundamentally similar to where it was in recent months and quarters, and we continue to want to invest in our commercial team and will invest in our commercial team in the years to come.

Okay. I've just got one follow-up, apologies here. Just how much of the business mix is typically comprised of shorter-term deals or maybe project-based work that would have experienced the missed opportunities with the choices you made due to the supply tightness?

I don't think we provide a lot of detail on this. However, as Brian mentioned regarding the bookings performance, the decline we saw in bookings was mainly due to shorter-term deals, which makes sense based on Brian's explanation. That segment was impacted, but the deviation from our expectations is relatively small percentage-wise. Nevertheless, we did experience more pressure on the shorter-term deals compared to the longer-term ones.

I just want to dig in a little more to your 3Q revenue guide. So it assumes a slowdown, right, in revenue growth from 2Q to 3Q. Are there any specific verticals or geography that you would call out that would cause that deceleration? And then second, your CMT revenue was very strong at 20% in the quarter. Any one-time items there? And how should we think of that growth going forward for the remainder of the year?

I wouldn't focus on specific factors by industry. Some of our industry groups face more challenging comparisons year-over-year, which is evident in our tables. Overall, I believe that the third quarter revenue guidance is influenced by our year-to-date booking performance to some extent. Additionally, our gradual improvement in attrition rates contributes to the revenue forecast we've provided in our guidance. Understood. And just on the growth in CMT in the quarter, any call out on...

Yes. As you'll see in the SEC filings, the Communications, Media and Technology business is our most profitable industry segment externally. We have tremendous momentum there, with a strong team driving good progress with digital native companies, fully leveraging our intuitive operations and automation business group as well. Our client relationships are robust, and we are executing well with a strong delivery excellence. Many of these clients speak highly of our unique offerings and differentiated delivery. This business has seen significant investment over the years as we diversified our portfolio beyond healthcare and financial services. Products and Resources within CMT have been growing double digits for many years, and CMT exemplifies our success both in the United States and internationally. There are no fundamental concerns regarding underlying trends; we just have strong momentum and a capable team. All right. With that, thank you, everybody, for joining our call. Look forward to catching up next quarter.