Cognizant Technology Solutions Corp (CTSH) — Q3 2022 Transcript

Thank you, operator, and good afternoon, everyone. By now, you should have received a copy of the earnings release and investor supplement for the company's third quarter 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 where appropriate to the corresponding GAAP measures can be found in the company's earnings release and other filings with the SEC. With that, I'd like to now turn the call over to Brian Humphries. Please go ahead, Brian.

Thank you, Tyler. Good afternoon, everyone. Third quarter revenue was $4.9 billion, up 5.6% year-over-year in constant currency, short of our expectations. Adjusted operating margin grew 90 basis points sequentially and 60 basis points year-over-year to 16.4% of revenue. While a non-certain macroeconomic backdrop impacted bookings and revenue, the primary driver of the revenue shortfall relates to a reduction in U.S. onshore billable resources in recent quarters, following a period of elevated attrition, a reduction in visa travel and a COVID-induced shift in the near and offshore delivery centers. The financial impact of this headcount reduction is magnified given this is our highest revenue and margin dollar per head population. To reverse this trend, we have already initiated a series of actions that are intended to increase U.S. onshore billable resources, including an enhanced focus on lateral hires and subcontractors, accelerated visa travel and targeted compensation programs. While these actions are gaining traction, it is somewhat slower than previously anticipated. We, therefore, expect these headwinds to continue in the fourth quarter, ahead of clear progress in Q1. Let me now turn your attention to global third quarter voluntary attrition, which was a little higher than expected in the quarter. Voluntary attrition fell 2 points sequentially to 29% on an annualized basis and fell 3 points sequentially on a trailing 12-month basis. We've taken extensive actions to increase employee engagement and reduce attrition over the past year. These initiatives, coupled with an uncertain macroeconomic backdrop, have led to reduced daily resignations, a leading indicator of voluntary attrition across the globe in the last 4 months. We expect sequential reductions in voluntary attrition to be more meaningful in the fourth quarter. To maintain positive momentum on resignations, we are continuing our comprehensive effort to attract, retain, and rally employees. We remain focused on our people strategy, which includes our refined promotion initiative, learning and development, and enhanced compensation and benefits programs. For instance, we recently communicated to our associates that we will accelerate next year's merit to the second quarter of 2023, meaning we will have 2 more cycles in the space of 6 months from most of our associates. I would like to now discuss the macroeconomic environment, which Jan will also address in our fourth quarter guidance. We see clients closely scrutinizing and slowing their investment decisions for the backdrop of uncertain economic conditions. Spending has been reduced on lower-priority projects or those with a longer return on investment. We're seeing some early signs of slowing in discretionary digital projects. Industry-wise, we've seen weakness in banking, especially in the mortgage segment, health sciences, and retail. In our international business, the U.K. remains solid, but deal cycles are slowing, while Continental Europe is showing signs of weakness. From a commercial point of view, despite a strategy to sell solutions and deliver client outcomes, we remain exposed to time and material engagement across all industries. We've seen clients curtailing this spending, and we expect furloughs to impact the fourth quarter. These factors contributed to a decline in bookings of 2% year-over-year in the third quarter, representing an in-period book-to-bill ratio of 1.0x and a book-to-bill ratio of 1.2x on a trailing 12-month basis. Turning now to our industry segment performance. Financial Services grew 1.6% year-over-year in constant currency, led by growth in our insurance business. This includes a negative impact of 180 basis points from the exit of Samlink. In insurance, carriers of all lines of business are enhancing their digital capabilities driven by demand for new insurance products and improved user experience. For example, Resolution Life US turned to us to execute several digital transformation initiatives that include large-scale data and application core modernization and cloud migrations. We're also helping them develop and scale advanced capabilities in data and analytics to drive significant operational efficiencies in our closed book portfolio. We were selected by AXA U.K. and Ireland as a technology partner to help consolidate, modernize, and manage their IT operations. AXA is transforming its technology ecosystem to create a more digitally enabled modern and agile environment that's data-rich, secure, and sustainable. Health Sciences revenue grew 5.5% year-over-year in constant currency, driven by digital services among pharmaceutical and healthcare payer clients. I'm pleased to note that our shared investigator platform, a SaaS solution for pharmaceutical companies that streamlines clinical trials to improve the speed of drug discovery, has surpassed 250,000 users across 100 countries worldwide. A Japanese pharmaceutical and biotechnology company has signed a multiyear agreement with Cognizant to provide global services and help improve patient health through the analysis of adverse reactions across its products. In Products and Resources, revenue grew 8.2% year-over-year in constant currency. Growth was driven by demand for our digital services among logistics, automotive, consumer goods, and travel and hospitality clients. During the quarter, we extended our long-standing relationship with Centrica, the U.K.'s largest supplier of energy and energy services, delivering business-critical services encompassing application testing, client infrastructure support, and IT infrastructure management. Communications, Media, and Technology revenue grew 10.4% year-over-year in constant currency, driven by strength among digital native clients. We're expanding our collaboration with Qualcomm to accelerate digital transformation through a new 5G experience center in Atlanta. The collaboration combines our deep expertise in 5G, IoT, cloud, and data analytics with Qualcomm's intelligent edge devices, AI, and 5G connectivity solutions. We've also had our first substantial win in the legal sector, which has traditionally been a latecomer to outsourcing and digital services. Freshfields selected us to manage their global IT operations and support their ambitious global expansion plans. We'll be providing 24/7 managed services of the firm's IT infrastructure applications as well as managing its service desk. Cognizant will also help define Freshfields technology transformation roadmap. As I mentioned in our last earnings call, targeted M&A remains an important tool for enhancing our competitiveness. We have several M&A targets in the pipeline in line with our strategy and capital allocation framework. As always, we continue to focus on opportunities that are value-accretive among our shareholders and align with our strategy. Yesterday, we announced an agreement to acquire the professional services and application management practices of OneSource Virtual, a Workday partner based in Dallas. These practices will complement our existing finance and HR advisory services on the Workday Cloud Platform. The acquisition is anticipated to close by year-end 2022, subject to the satisfaction of closing conditions. At which stage, we expect to welcome nearly 400 new employees to our strategic Workday practice. Importantly, we continue to strengthen our leadership team. Last month, Ravi Kumar, President of Cognizant Americas, will join us in mid-January from a leading firm, where he served as President for the past 6 years. Ravi brings client centricity and a growth mindset that we believe will help improve our U.S. revenue trajectory. We also announced Prasad Sankaran as the new Head of our Software and Platform Engineering Practice. Prasad joined us yesterday from Bain, where he was a Senior Vice President in the firm's Enterprise Technology Global Practice. Prior to that, he spent 25 years in senior leadership roles with Accenture. Both announcements speak highly of our ability to attract world-class talent and support two key strategic areas for Cognizant, the Americas region and leading enterprise technology transformation. Before passing the call to Jan, I would like to stress that while we're in a period of economic uncertainty, the entire leadership team knows we must execute better on things that we can control, including optimizing our resources globally and getting the right mix onshore and offshore in a dynamic demand environment. We will continue to focus on and hone our operational discipline, which is intended to enable us to adapt quickly to demand changes. While we're in an uncertain macroeconomic environment, we remain highly optimistic about the key services market and our opportunity within it. Finally, following sustained progress in reducing voluntary resignation rates, we expect sequential reductions in voluntary attrition to be more meaningful in the fourth quarter, allowing us to pivot client conversations from fulfillment to innovation, strategic transformation, and growth. With that, I'll turn the call over to Jan, who will cover the details of our quarter and our fourth quarter financial outlook before we take your questions.

Thank you, Brian, and good afternoon, everyone. Q3 revenue was below our guidance range, driven primarily by lower billable headcount in North America. Higher-than-expected attrition, coupled with strong competition for talent in North America, made it challenging for us to maintain required staffing levels to meet our revenue forecast. An uncertain macroeconomic backdrop led to pockets of bookings and revenue weaknesses in certain industries. The weaker-than-expected revenue performance was offset by commercial discipline, the benefit from the depreciation of the Indian rupee and SG&A leverage, which resulted in sequential and year-over-year operating margin expansion. Now moving on to the details for the quarter. Q3 revenue was $4.9 billion, representing an increase of 2.4% year-over-year or 5.6% 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 this year. In Q3, digital revenue as reported grew 7% year-over-year or 11% at constant currency. Digital represented approximately 51% of total revenue for the quarter, up 2 points from the prior year period. Our slower digital revenue growth reflected the expected lower inorganic contribution we discussed last quarter and the lower billable headcount in North America mentioned earlier. These factors and the softening demand environment also contributed to a bookings performance below our expectations. Q3 bookings declined 2% year-over-year and represented an in-period book-to-bill of approximately 1x. This resulted in a trailing 12-month bookings of $23.1 million and a book-to-bill of approximately 1.2x, unchanged from Q2. Brian has already taken us through the segment performance, but I will spend a minute discussing several trends we are seeing emerge across our two largest segments. Within Financial Services, banking revenue growth slowed this quarter. This portfolio has a higher mix of time and material business, which we believe is more vulnerable to changes in the economic outlook of our clients. Additionally, mortgage clients have been impacted by rising interest rates, which has a negative impact on our results. These headwinds were offset by continued growth within insurance, particularly within property and casualty, where we are seeing good traction in both middle market and large global carriers. We're continuing to invest and strengthen our banking and financial services portfolio to improve the revenue trajectory over the medium term. Within Health Science, our growth was again driven by demand for digital services among pharmaceutical companies. Healthcare payer growth was consistent with last quarter, and we have seen the ramp-up of integration-related services following the software product growth earlier this year. However, the healthcare industry has not been immune to pressures driven by the macro uncertainty as we have seen softer demand both across healthcare payer and life sciences. Clients are slowing discretionary spending as they await greater clarity on the economy and navigate an increasingly complex regulatory environment. Continuing with the year-over-year revenue growth in constant currency, from a geographic perspective in Q3, North America revenue grew 4%. Growth was led by CMT and Health Sciences. Our global growth markets, or GGM, which consists of all revenue outside of North America, grew approximately 10%, including a negative 220 basis point impact from the sale of Samlink. Growth was again led by the U.K., up 19%, which had a strong double-digit growth within Financial Services, including public sector clients. Now moving on to margins. In Q3, our GAAP and adjusted operating margins were 16.4% as there were no non-GAAP adjustments in the quarter. On a year-over-year basis, GAAP operating margin increased by 100 basis points, and adjusted operating margin increased by similar amounts. Year-over-year, margin expansion was primarily driven by SG&A leverage, while gross margin pressure from increased compensation costs was partially offset by delivering efficiencies and disciplined pricing. We also experienced a meaningful tailwind from the depreciation of the Indian rupee, delivering an approximate 80 basis point benefit, net of hedges year-over-year. Our GAAP tax rate in the quarter was 22.5%, which included the benefit from a discrete tax item in the quarter. Adjusted tax rate in the quarter was 25.2%. Q3 diluted GAAP EPS was $1.22, and Q3 adjusted EPS was $1.17, up 18% and 10% year-over-year, respectively. Now turning to the balance sheet. We ended the quarter with cash and short-term investments of $2.7 billion or net cash of $2.1 billion. Free cash flow in Q3 was $953 million, representing approximately 150% of net income, in line with our expectation. This brings year-to-date free cash flow to $1.6 billion or 92% of net income. DSO of 74 days was flat sequentially and increased by 2 days year-over-year. During the quarter, we repurchased 5 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 approximately $1.5 billion through the first 9 months of 2022. Turning to our forward outlook. We are revising our full year guidance downward, which reflects headwinds from currency, lower North America billable headcount, which we expect to take several quarters to improve, and softer-than-expected bookings growth. Offsetting these factors are several tailwinds, including sustained reductions in resignations globally and our expectation for lower attrition in the fourth quarter. For Q4, we expect revenue in the range of $4.72 billion to $4.77 billion, representing a year-over-year decline of 0.2% to 1.2% or growth of 2% to 3% in constant currency. Our guidance assumes currency will have a negative 320 basis points impact as well as an inorganic contribution of approximately 30 basis points. Together, these factors contribute to our revised full year revenue guidance of approximately $19.3 billion, representing year-over-year growth of approximately 4.5% or 7% in constant currency. This assumes approximately 100 basis points of inorganic contribution. Our reported revenue outlook now assumes a negative 220 basis points of impact from currency versus 220 basis points previously. This compares to our prior full year revenue guidance of $19.7 billion to $19.9 billion, which represented growth of 6.3% to 7.3% or 8.5% to 9.5% in constant currency. We expect our full year operating margin to be approximately 15.6% at the low end of our prior range. This implies Q4 adjusted operating margin of around 15.3% at the midpoint of our EPS range, reflecting the reduced revenue outlook and the annual merit cycle for most employees that is effective October 1. Our full year outlook assumes interest income of approximately $50 million versus $35 million previously, reflecting higher interest rates. We still expect average shares outstanding of approximately 519 million, unchanged. Our tax guidance of 24% to 25% is unchanged. Finally, our revised full year adjusted EPS guidance of $4.43 to $4.46 represents growth of approximately 7% to 8%. This compares to prior guidance of $4.51 to $4.57. Our longer-term capital allocation framework remains unchanged. We are pleased to announce our agreement to acquire the professional services and application management practices of OneSource Virtual yesterday, and we expect our acquisition pipelines to remain active. Our share repurchase assumption for the full year is unchanged at $1.2 billion. As always, this remains subject to market conditions and other factors. In support of our balanced capital deployment strategy, the Board has also approved a $2 billion increase in our share repurchase authorization, which brings our total remaining authorization to over $3 billion as of today. We are also still targeting full year free cash flow conversion of approximately 100% of net income. Before opening the call for questions, I want to reinforce that the leadership team is focused on addressing the operational challenges impacting our recent results. We are also closely monitoring macroeconomic factors to help enable us to quickly respond to changes in the demand environment. Longer term, we remain confident in our market opportunity. With that, we will open the call for your questions.

I'll start on the attrition point that you've raised that seems to, I guess, be at the root cause of some of the challenges you're having both on revenue and on bookings. In the past, you've focused a lot on the initiatives you're undertaking in India related to attrition and haven't spent as much time on the dynamics of what's going on in North America. Can you just elaborate a bit on what exactly is happening in North America? Is this recent? Have you pinpointed like specifically what's causing the elevated attrition and maybe elaborate a bit on the time frame and the steps you're taking to address it?

Lisa, it's Brian. So look, at a global level, I would say we're doing similar things in North America as we're doing in India. Clearly, on a weighted basis, India had the biggest impact on our attrition historically. So we put inordinate efforts and war rooms in place over there. And frankly, in India as well as in North America and our international business in Europe and Asia, we have seen resignations come down pretty much for 4 to 5 months in a row now. So those efforts are kicking in, and those efforts are broad-based, including the obvious compensation elements. And as we announced, we just announced our second merit increase in 6 months. But on top of comp, there's merit, there is a career path progression, promotion process overall, learning and development initiatives, et cetera. And so the North America efforts are somewhat similar to what we're doing globally. I think in North America, we've gone through a pretty material visa process in the last 3 years as we reduce our visa dependency. But obviously, in a tough market environment where digital skills are at a premium, we've been suffering attrition in North America, and by definition, obviously going out as fast as we can to recruit talent simultaneously. And those factors, coupled with what's effectively happened across the industry and ours, was no different. A shift to nearshore and offshore during COVID has led us to have a suboptimal level of onshore billable resources in North America, and it catches up quickly with you because of the order of magnitude of the difference in terms of revenue and margin dollar per head in North America versus in India. So it's a question of rebalancing that. We have major initiatives underway, operational rigor behind it. We had hoped to make more progress in the quarter. It's a little slower than we anticipated, but we're putting a lot of effort behind that to correct it. And it's all of the factors we mentioned above. At a global level, we're expecting significant voluntary attrition reductions now going into the fourth quarter. The goodness of the last 4 months will kick in, in Q4.

Got it. Okay. And then I remember last quarter, you mentioned the connection between the attrition challenges and bookings, and that you were taking steps to address the bookings issues or that connection. It seems like some of your salespeople were worried they couldn't staff a project, which caused delays. This issue appears to have continued into this quarter. So can you elaborate on that?

Yes. Look, I mean, let me start with the facts first on bookings. They were down 2% year-over-year, a little below what we had hoped for the quarter, to be honest. It is important, I'd say, to recognize the tough comparison in the second half of last year with 20% plus bookings growth. So that leads to even an in-quarter bookings book-to-bill of 1.0, and on a trailing 12-month basis, still at 1.2. So healthy enough, although, frankly, we lost some deals in the quarter that slipped out quarters. And that's, I think, somewhat indicative of an uncertain macroeconomic demand environment. We've seen lengthening purchase cycles and clients being a little bit more judicious in their approval of expenses. But Lisa, specific then to the impact of attrition, by definition, as people were dialoguing with clients around price increases, which has been one of our success stories, helping margin as well as addressing fulfillment challenges, it's made the commercial team somewhat hesitant, I think, to go to full mode to get the commercial momentum as strong as it needs to be in terms of increasing pipeline and accelerating bookings. The good news now is we're quite vocal with our team in terms of what we're seeing from a resignation point of view, and therefore, what they should be anticipating in Q4 in terms of attrition levels, which, as I said, will be meaningfully down from Q3 voluntary attrition levels. So I think we're starting now to get confidence in the commercial team that the effort we put in place around attrition and resignations will kick in. Of course, this is happening in a period where, as I said on the call, we're a little more concerned now than we were 3 months ago in terms of the macro demand environment. So that's probably been a bigger impact on bookings this quarter than previously, the whole concern amongst the C-suite as they're scrutinizing their spends, and it's not clear to me that we'll see a budget flush at the end of this year, and we'll certainly anticipate furloughs at the end of this year relative to last year. So it remains to be seen, and we factor that into our guidance.

Yes, guys. So you have 4% constant currency growth in North America and essentially 10% outside of North America. So I wanted to ask how you feel about your progress and outlook in ramping your international revenue presence and also ask if your efforts in doing that are detracting from your efforts in North America or perhaps it's just that your talent challenges are more pronounced in North America, but some color on that would be really helpful.

No. I'll begin with the international business, which we anticipate will perform very well in the coming years. We've refreshed some leadership in that area and made senior hires and added M&A to enhance their capabilities. This includes efforts in the U.K., Germany, and Australia. I have spent a significant part of the last year traveling globally, and I'm quite optimistic about our international potential. However, this does not detract from our focus in North America. In Canada, there is a noticeable shift towards offshore and nearshore operations, and we are expanding our capabilities there. Honestly, there has been a shift towards India as well; our net headcount in India has substantially increased year-over-year, and we need to find the right balance. Three years ago, we relied heavily on visas in North America, but we have been disciplined in managing that as we work to optimize our approach. What has occurred during COVID is that international consulates have not been operating at full capacity, which has posed challenges. This has impacted our attrition over the past 2 to 3 years as people found opportunities to be less available than in the past. However, as we gradually address this and rework our strategy in line with consulate capacity, it will not only boost onshore headcount but also likely improve morale and reduce attrition in India. Therefore, I believe that the situation in the U.S. onshore market is separate from the positive developments I see internationally, and I remain very optimistic about our future potential in that realm.

Great. And let me ask a follow-up about the cloud services market. We definitely see some changes happening in that market. So I just wanted to ask about what you're seeing in that market, particularly your competitive position there, and to what extent some of the recent macro challenges are having an impact in cloud or maybe not so much. It'd be great to hear some thoughts on the cloud market.

Well, first of all, I'll actually call out Prasad Sankaran, who joined us yesterday. He's got a very strong background in cloud as well. So he and I spent a great deal of time talking about where that market is going. Ironically, in the client Advisory Board last week, it was a great topic of discussion amongst clients too. I would say our position with some of the packaged application players like Salesforce and Workday is stronger than it's been for many, many years. And so we feel good about the progress there. And yesterday's announcements of OneSource Virtual will continue to strengthen our Workday practice. Vis-a-vis the hyperscalers, it's kind of interesting. I'm seeing clients clearly accelerate their path to the cloud. Within the same vein, Rod, I see a growing dialogue amongst clients around how to optimize your position in the cloud as in lifting and shifting your current suite of applications. It doesn't necessarily always give them the efficiencies that they would have anticipated. So there's more dialogue around how to optimize your cloud journey. What you'll see us do and continue to do is stand up capabilities and resources behind that, both in the cloud practice and in our consulting business as we anticipate cloud modernization journeys or tech more generally, you'll see us add more advisory capabilities there as well.

Could you talk about what you're seeing in digital especially since you mentioned slowing discretionary spend? Is that more of a company-specific positional thing because other companies have spoken to have not yet mentioned anything specific with regards to digital specifically slowing down?

The current macroeconomic environment is quite uncertain, making it difficult to draw definitive conclusions. The outlook has become more concerning compared to three months ago, as we are observing reductions in spending for lower-priority projects or those with longer return on investment timelines. Even discretionary cloud initiatives, as I mentioned earlier, are being selectively scaled back. However, we remain confident in our digital capabilities, with our portfolio now being 51% digital, up two percentage points year-over-year. The challenges we previously discussed regarding macro demand and the situation in the U.S. also apply here. Additionally, we announced our first acquisition of the year yesterday, and we haven't had the same boost to our digital momentum this year as we did last year from multiple acquisitions. Nonetheless, as Jan pointed out, we are committed to expanding our portfolio in line with our digital strategy, and there are several deals in progress. I expect that, over time, we will return to a more typical pace, but I do not think all digital projects will be insulated from the current economic conditions.

And maybe in addition, Ashwin, to give you a little bit more of the framework on the M&A side, our full year guidance assumes approximately 100 basis points of contribution from M&A, approximately half of what we typically see. If you multiply that type of share of digital revenues, you'll see there is an impact on just mathematically on the lack of M&A fueling digital growth. And then aside from the demand market demand that Brian mentioned, obviously, in North America, we are also affected by our fulfillment challenges that we experienced in the quarter, which proportionately affected our non-digital business as well as our digital business. So it's a combination of all these factors together.

Got it. Got it. And what does this lower exit growth rate for the year means in terms of achieving sort of your medium-term targets? And I completely appreciate the high level of macro uncertainty that we have, but any granular thoughts how you're planning for next year would be greatly helpful.

Yes. So that somehow I thought the question would come up. So number one is we feel our growth framework that we discussed with you pretty much a year ago, a little bit more than a year ago, is still intact overall. Maybe a few pointers, the growth framework sees our revenue growth, which you're referring to, really in light of a CAGR over the 3-year time horizon. So it's a compounding growth. Obviously, we didn't quite anticipate at that point the economic uncertainty that we're facing today, but we think the framework from our perspective is intact. We will give guidance, obviously, for next year in our fourth quarter earnings call in January.

Regarding the fulfillment challenges, I understand this was an issue last quarter and seems to have carried over into this quarter, resulting in missed guidance, possibly due to the economy as well. I'm trying to gauge your comfort level with the numbers for the fourth quarter. Is there a possibility that some fulfillment issues might still persist, potentially leading to lowered expectations again?

Yes. I'll start with that and then let Brian add to it. As Brian mentioned during our call, the mix had several logical factors in fulfillment. We underestimated the improvement in attrition during the third quarter, which accounted for about one-third of our shortfall relative to our expectations. Additionally, we have several initiatives aimed at accelerating hiring, particularly in North America, which also contributed roughly one-third to our revenue guidance miss. We faced challenges in growing our headcount in North America, but we are implementing various initiatives, including ensuring we have the capacity to hire, utilizing subcontractors, expediting visa travel, and enhancing employee referral programs. While these initiatives have shown some initial progress, they are scaling more slowly than we anticipated. We now have a clearer trajectory and believe we have accurately adjusted our new revenue guidance to account for risks. We are eager to meet our own expectations. We expect an improvement in attrition levels, and we now have a better understanding of the trajectories for some of these initiatives than we did in the third quarter.

Yes. And just to build on that, the resignations visibility we have, of course, differs in India versus North America because the notification period in India is slightly different. But I mentioned on last quarter's earnings call had July resignations have come down, and through August and September, it was a different plateau for those 3 months vis-a-vis the prior 6 months. Certainly, if you look at India and indeed in North America and Europe, and in the first month of this quarter, it's continued to be low, in fact, lower than the prior 3 months. So we feel, Bryan, at this stage, very, very confident about that. And as Jan rightly pointed out, we wanted to give guidance that we want to make sure we can hit. So we're in the right zone.

Got it. And then did the fulfillment challenges, especially in North America, will that be fixed by the time we get into the first quarter? Or could it linger into the first half of the year?

We're working through this as quickly as we can and aim to make progress in Q4, but I think it will still be a challenge during that period. We hope that by the end of Q4, we will have clear progress to share in next quarter's earnings call, allowing us to start Q1 on a positive note.

This is a question for Brian regarding the fulfillment issues. Can you provide some real-time insight into the discussions you’re having with clients? Considering all the rebranding and repositioning the company has undertaken in recent years, what steps are you taking to reassure clients that you are their preferred digital transformation partner?

We actually see different stories, to be honest, across different industries in terms of our evolution towards digital, even banking where we are, let's say, more heavily exposed to time and materials. We have been able to increase our digital mix, and we've got some good proof points with certain clients. But more fundamentally, the journey we've been on is to extend the portfolio, which we've been successfully doing in recent years, and yesterday's announcement is another example of that. To try to complement that portfolio then with a client-facing team that is more consultative in nature as anybody who's overseen a sales force and knows that is a multiyear journey. So we're en route, but it takes time to get there. To complement then that more consultative sales force with a more industry-aligned consulting business, and so that's the space we should continue to watch in Cognizant because we will invest behind that, and we've got strong leaders in the capacity these days, and then just to make sure that there's increasing brand awareness around the capabilities we have and references and case studies that we can showcase. Last week in the Client Advisory Board was a very good example of certain clients not really being truly aware of the extent of our portfolio. So we have to be more vocal about ourselves. But I would say brand awareness of the company is up. Digital awareness is increasing, but it's a multiyear journey, and we're in the middle of all of that. It starts with our client-facing teams and our delivery capabilities and our partnerships. I certainly see in dialogue with some of our key packaged application partners like Salesforce and SAP, growing recognition that we are getting stronger. But as ever, a few years ago, we were quite low in terms of digital mix, and we've been working our way back up to 50%, which we're pleased to cross, but there's more work to do.

Got it. That's helpful. And just a follow-up. The forward-looking attrition commentary is encouraging. You've been vocal about the new normal for attrition being higher than pre-COVID levels. Perhaps you can share updated views here and the timeline for when attrition is more in a steady state mode as it relates to attrition.

It’s quite challenging to be precise on that, Bryan. There’s a lot happening in the world today. We've seen a significant disconnect between demand and supply for key digital skills. We're now adapting to a hybrid work environment, where people may feel less connected to their companies while working remotely. Additionally, the economy is uncertain and slowing, which has led to layoffs among recruiters globally and in certain companies. The job market seems less vigorous than before, which could affect attrition trends and voluntary resignations. Over time, we’ll see how things stabilize. I’m optimistic about the actions we’ve taken, and we’ve included these in our financial plan. Despite the slowing labor market, we are committed to sustainably investing in our employees in the coming years, which is part of our multiyear financial strategy aimed at improving our compensation relative to our peers. At the same time, we are focused on training, development, career paths, and enhancing the employee value proposition. I’m unsure when things will settle into a new norm, but I believe that a new equilibrium will emerge, and we won't return to previous historical levels. As a broader society, we could see attrition slow down across the industry in Q4 and beyond, but we will have to wait and see.

In terms of skills related to fulfillment, what challenges are you facing in finding the right people and integrating them into your fulfillment capabilities? How do you perceive the overall structure in addressing these issues, and how does this influence your financial guidance? It’s a complex question, but I hope it’s clear.

Yes, it's quite nuanced. Our headcount has significantly grown year-over-year, primarily in India, leading to different billing rates. In India, we have more entry-level employees than in the last few years. This year, we're bringing in about 40,000 graduates, compared to 45,000 last year, 33,000 the year before, and under 10,000 previously. We had previously been too focused on a narrow range of hiring, but we have made progress in addressing that. This growth has allowed for greater upward momentum in the company, contributing to margin expansion in both Q2 and Q3. However, the main issue regarding the demand-supply imbalance and key digital skills is closely tied to roles related to hyperscalers, such as Salesforce and full stack engineers. These roles have seen increased demand, along with irrational salary hikes over the past 18 months, which has created challenges, particularly in India at the lower levels of the workforce.

Got it. I have a related question regarding the P&L and margin impact. Can you explain the effects and mechanics of merit cycle changes? Are these changes accelerating and will they be permanent? Should we anticipate two cycles a year? I'm trying to ensure that we accurately consider how this impacts the P&L.

Yes, I can address that. We are moving our typical merit cycle from the fourth quarter to the second quarter to better synchronize our HR, evaluation, and reward processes. This shift will benefit talent management by enabling merit increases to occur earlier. Additionally, since we are advancing this merit cycle by two quarters, there will be a one-time shift in compensation that occurs sooner, but we will return to our annual merit increase process in 2024. Next year, we will revert to the regular cycle in the second quarter. This change provides an opportunity to enhance our talent management while also allowing for quicker compensation increases for our associates. We believe this is crucial for addressing attrition, and while its impact may be difficult to quantify, we feel it will demonstrate our commitment to being competitive in terms of compensation and benefits.

Just thinking about the knock-on effects of the fatter pyramid plus the attrition. Just is there an impact there on your ability to capture price or even be competitive on pursuing new work bookings, that sort of thing? Just trying to understand sort of the collateral impact because you're seeing some of that.

I would like to discuss our overall gross margin development, particularly in relation to your focus, Tien-Tsin. We have observed a decline, but our relative performance compared to the industry has been quite strong. There are a few key factors to consider. When we talk about pricing, it's important to view it as regular contractual increases with our clients, as well as maintaining discipline in how we price our services in the market. Initially, we experienced a slow start to the fiscal year, but we've seen steady improvements and a cumulative positive impact from our initiatives. This progress has contributed to a better relative gross margin performance. Additionally, the changes in our organizational structure have been beneficial. We have largely managed to offset the effects of compensation and benefit increases by streamlining our structure and focusing on a more efficient model, while also providing promotion opportunities for our associates. As that continues to develop over the next couple of years, it should positively influence our pricing strategy and our ability to win deals. We are optimistic about the enhancements we are making in managing business opportunities. This is a deliberate process that enables us to make informed strategic decisions moving forward. I believe our margin profile is solid, which will allow us to pursue strategic initiatives aimed at driving revenue growth from a more stable foundation than we currently have.

The only thing I would add there, Tien-Tsin, is I don't think we were doing anything except correcting what was an overly narrow pyramid back in the day. And on the contrary, I think because we had somewhat canceled the college intake in prior years, it led us having folks further up the pyramid doing work at lower billable rates than were optimal. So I think what we've done in India is appropriate, and it's more in line with industry rates based on the dialogue I have with those from other companies. Where we have to do a better job on campus and college graduates, I think, is both onshore in Europe and Asia as well as in North America, where we are not adequately getting after the market opportunity there. Obviously, there is a war on talent still. So we have to look at vocational colleges and not just the classic places as well, and that's an area of focus we'll have. Fortunately, with Ravi coming on board in North America, he has run a play there previously, which we will obviously aim to replicate over here. That can help our pyramid. But generally, I feel good about our skills in our pyramid. I think we corrected something that was mis-skewed. I don't want anybody to get off the call worried about our skill set in our pyramid where we've got very talented employees, and I feel good about that.

Just quickly, if you don't mind, a quick follow-up, just on the capital allocation front. I have to ask a capital allocation question. Just with the buyback of the authorization here, just your appetite to back stock. I know you talked about the acquisition you just announced. But just thinking about buyback here at this point in the cycle.

Yes. For this fiscal year, we gave you basically our anticipated number of $1.2 billion. And you see over the last few quarters as we have been lacking in M&A activities that we basically redirected excess cash to return to our shareholders. That's the general philosophy that we've been following with no intent to build up cash on our balance sheet. That flexibility is in the model. We are seeing a good pipeline, though, of our M&A activity. This we announced the deal, but compared to last quarter, we really moved the needle forward on our business development activity with a very talented team. We see also, I think, a little bit more realistic behavior in the market relative to acquisition opportunities. For us, the goal would be to get back to normal capital allocation framework that we have been talking about for a long time. It's going to be the mindset for us going forward.

Can we go into a little more detail on the different verticals, starting with Financial Services and any others you think are relevant? I’d like to understand what you believe is influencing the changes in outlook, whether it's primarily due to macro factors and demand, billable headcount availability, or any other elements such as technology or competitive dynamics. I'm trying to identify what is driving the narrative and what improvements can be made internally versus those related to the overall market.

Yes. Look, it's a good question. I mean I'll start with the 2 bigger ones, Financial Services, which is about 31% of the company. It grew about 1.6 points in constant currency, but that was impacted by the exit of the Samlink business, which was previously disclosed to the tune of 180 basis points to normalize, let's say, 3.4 points of growth. And that's the low industry. We've got a lot of work to do there, as we've cited previously. There is a slowdown in certain segments there we've touched upon in the prepared remarks, particularly the mortgage segment. I'm also seeing some of the C-suite there talking about tightening their belts as they go into the fourth quarter and beyond. I think that will be a tougher sector for others as well. Fundamentally, our bigger issue there that we're evolving from, it's not just the folks we have in front of those clients, but also how the clients think of us. We've very often trained them to think of us as a provider of resources. I'm pleased to say that our digital mix in Financial Services is improving, and our staff or time and material mix is not improving enough yet. So we have to get that balance right in the period to come. Insurance, we're doing better than banking, and that's obviously in banking area we've got to go fix. In Health Services, we feel very good about our position on a relative basis or a competitive basis in both payer provider as well as life sciences. That's one of our core franchises, I would say, as a company. The business grew about 5.5% in constant currency year-over-year. It's 29% of our business. So it's catching up on Financial Services overall. Then if I talk about the other 2 portions of the business where we have actually historically in the last 2 years, 3 years, been growing double digits, CMT is a good success story of ours. We've had good client acquisition there, good constant currency growth. Products and Resources, I think we have a lot of room to continue to do well there because our penetration of large accounts is lower there than it is, as an example, in life sciences, or indeed, the payer business where we are heavily penetrated into the major players. So that's kind of how I think about the framework. The factors we touched upon today, elevated attrition across the industry and Cognizant, within that permeated across all industry segments, and indeed, the U.S. onshore situation permeated across all as well. So nothing specific to either of those.

All right. Just one quick follow-up on the margin side. It did come in well. And I mean your guidance is relatively unchanged also for margin. So just thinking about that in terms of going forward a little more than just the fourth quarter, it would seem that if wage inflation calms down a bit, you should be able to maintain that level. Is that a fair assumption?

In the third quarter, we provided guidance for the fourth quarter. I want to emphasize that our overall multiyear framework remains intact, not just in terms of revenue but also regarding our margin expectations. When evaluating margin results, it's crucial to consider several factors. We've achieved margin expansion through effective control and discipline in SG&A, which has enabled us to leverage SG&A as the company grows. Additionally, the depreciation of the rupee has significantly supported our business. While gross margin faced pressure, various actions we've taken helped mitigate what could have been a more significant impact. We believe we have a solid process for balancing the business and are committed to maintaining that discipline while accelerating revenue growth. This is our primary focus, as it's our greatest opportunity, and we view the margin profile as a strong foundation for this growth.

Great. Thank you all for joining. Look forward to catching up next quarter.