Genpact Limited (G) Earnings Call Transcript & Summary

Thanks, Michelle, and good afternoon, everyone, and welcome to our third quarter earnings call, where we'll discuss the results for the period that ended September 30, 2022. We hope you've had an opportunity to look over our earnings release, which was posted to the IR section of our website, genpact.com. On today's call, our speakers are Tiger Tyagarajan, our President and CEO, and Mike Weiner, our Chief Financial Officer. Here's what today's agenda looks like. Tiger will give an overview of our results along with an update on our strategic initiatives, and then Mike will take you through our financial performance for the quarter and also share our current thoughts on our outlook for the full year 2022. After that, Tiger will return for some closing remarks, and then we'll open things up for your questions. We expect this call to run about an hour. A number of the matters we'll discuss today are forward looking and involve a number of risks, uncertainties and other factors that could cause actual results to differ materially from those in such forward-looking statements. Those risks and uncertainties are set forth in our press release. Also, during today's call, we will refer to certain non-GAAP financial measures that we believe provide additional information to enhance the understanding of the way management views the operating performance of our business. A reconciliation of those measures to GAAP can be found in today's earnings release posted to the IR section of our website; and with that, let me hand the call over to Tiger.

Roger, thank you. Greetings, everyone, and I'm grateful you could be here for the earnings call covering our third quarter of 2022. Our results for this period were once again solid, as revenue, adjusted operating income margin, and adjusted diluted EPS each landed right where we had anticipated. For our Data-tech-AI offerings along with Digital Operation Services, demand remains robust, since we continue assisting clients in addressing pressing challenges tied to cost and productivity, growth, risk mitigation, and building lasting resiliency into their operating models. Given these conditions, we believe that because most of what we provide is essential and nondiscretionary in nature, our value to clients only grows. Let me lay out the specifics for Q3 of 2022. Our total revenue came in at $1.111 billion, which represents growth of 12% on a constant currency basis. Revenue from Data-tech-AI services reached $510 million, an increase of 21% on a constant currency basis. Digital Operations Services brought in $601 million, rising 6% on a constant currency basis. Our adjusted operating income margin stood at 17.1%, which is 50 basis points higher than the same period a year earlier. Adjusted diluted earnings per share were $0.75, up 14% compared with a year ago. Demand overall is still healthy, and our high-quality pipeline bears that out. Our business model is built to last and withstand pressure, made up mostly of revenue streams that resemble annuities, generated by designing, building, transforming, and running mission-critical operations for clients in the industry segments we have selected. Given the unprecedented macro environment, many clients are acting cautiously. We've observed some multistage large-scale transformational deals being split into medium-sized deals that provide faster payback and return on investment. Meanwhile, we've witnessed a dramatic rise in how important the cost agenda is across every industry segment we serve. What many clients are doing is finding ways to preserve strategic long-term transformational programs and fund them through aggressive cost initiatives, where we are serving as their partner. Consequently, bookings in the quarter were supported by higher levels of medium and small deals, with roughly 2/3 of the total being annuity-based and nearly half sole-sourced, already consistent with the past many quarters. Several sizable deals are progressing through the later phases of our pipeline in each of our 3 industry segments, and we can see a clear path for a number of them to be finalized prior to year-end. Another thing I'm pleased about is that we continue to bring in new logos, having added 34 during this quarter, versus an average of 29 across the 12-month period that ended June 30 of this year. A lot of these start out as initial data tech AI relationships, which then create the opportunity to grow the engagement past that first scope by drawing on the range of services we offer that speak to various challenges our clients are dealing with today. For the quarter, total revenue increased 12% compared with the same period a year earlier, measured in constant currency. Expansion occurred across every industry segment we serve, with especially robust double-digit gains continuing in financial services as well as hi-tech and manufacturing services. Within data-tech-AI services, where we build a variety of offerings designed to change how clients operate, the business grew 21% against the prior year in constant currency. Demand for our newer solutions drove that result, including supply chain management, sales and commercial, and risk, which exceeded 25% once again during the quarter. We saw another stretch of steady expansion in our digital operations services — the part of our business where we digitally transform and run client operations globally — with a 6% increase year over year measured in constant currency. During the quarter, we continued executing the strategic moves we introduced at our Investor Day in June. We're positioning ourselves to hit our long-term financial targets: organic top line revenue growth of 10% or more, plus profitability that expands faster, and more substantially, than it has in the past, continuing all the way through 2026. Let me walk through a few examples of the progress we're making. First off, sales from the accounts we prioritize rose 14% year over year, and they account for 65% of everything we bring in. Our spending on these customers is outsized because they're on big transformation paths; we keep finding chances to link up different parts of their business so they get real outcomes; think of combining finance and accounting with supply chain, or pairing financial risk and crime with customer service. Through this work, we're reimagining workflows that touch several buying centers, and that drives company-wide, integrated change; for instance, we helped one big worldwide tech firm broaden where it sources semiconductors so its supply chain stays strong over the long haul. Through digital and analytics work, we helped them get better at projecting supply and demand, and we enabled worldwide inventory review plus spot price prediction, which let them choose better moments to buy. Our relationship is now expanding into a long-term digital operations arrangement, and through it we'll run their demand planning activities across every new growth opportunity. Turning to commercial structures tied to outcomes and consumption, these represent 12% of total revenue at present, and our aim is to reach 20% by 2026. Because such arrangements link to results and performance goals, clients receive more value and we're able to deepen our ties, particularly with priority accounts. Another point worth noting: they tend to come with stronger margins, given that a risk-reward framework is built into them. And finally, we are honing our focus and doing a better job of directing our resources, capital and leadership bandwidth toward the areas offering our strongest long-term opportunities. Accordingly, we are moving ahead with plans to divest a small business that we classified as held for sale in the previous quarter. We compete in a growth market that remains underpenetrated and should keep expanding as time goes on. Today's macro environment opens up opportunities for us as we guide our clients through a landscape that is shifting quickly, with cost concerns front and center. We observe this among new clients who, for the first time, have grown more willing to enter partnerships in order to change and transform themselves amid this uncertain environment. During the last 6 months, we brought in 64 new logos. That includes 9 that are first-time purchasers across every category of service, and a number of those agreements exceeded $5 million. Beyond that, relationships that began with data KPI transformation through our emerging services are now pursuing cost transformation, drawing on our foundational offerings in procurement, finance and accounting, insurance, and banking back-office operations. A lot of these broader engagements came to us on a sole-source basis, and we prevailed thanks to the domain and process depth we hold within our chosen verticals. Let me walk through a few illustrations of these patterns. With a European pharmaceutical client — an organization outsourcing for the first time — we are working as partners to digitally transform their back office so it can underpin future growth, reduce costs, and generate improved outcomes like cost and cash flows. We are designing, implementing, and will be operating finance and accounting and IT services, making use of digital technologies including Genpact Cora and Robotic Process Automation, plus deploying ServiceNow as a shared business workflow platform. This is a great example of a new connection that has real promise to become one of our key accounts, given how quickly we anticipate it growing. Now, on to a sizable industrial manufacturer we work with: the supply chain overhaul we just completed for them using Data-tech-AI produced measurable gains, improving how they forecast demand and plan supply. Because of that, we're now positioned for a long-term, sole-sourced digital operations transformation engagement spanning their sourcing and procurement functions, with the goal of driving savings across everything they spend.

What we're seeing is that these trends are making a lot of our relationships bigger. Across the 12 months that closed on September 30, 2022, the count of relationships generating over $5 million in yearly revenue rose from 143 to 158. Accounts bringing in more than $25 million annually went up from 27 to 34. Those above 50 million in revenue climbed from 11 to 14. Our quarterly attrition dropped to 36%, compared with the 38% we reported in the prior quarter. It's still too soon to declare that we're headed toward a more normal level, but our attrition figure got better in every month of the quarter, and it has kept falling through October. Most of the attrition remains clustered at the bottom of our organizational pyramid, where we can fill positions fast enough to satisfy demand. As we mentioned last quarter, our attrition number captures every employee who departs the company, no matter their tenure or the reasons behind it. If we adjust for involuntary departures and for staff with under 3 months of service, attrition for the third quarter comes out at 33%. Over the quarter, we brought on over 14,000 new team members around the world, as our purpose — the relentless pursuit of a world that works better for people — along with our values and a strong chance to learn and advance one's career keeps drawing excellent talent at every level, even in a competitive market. On top of that, by using Talent Match, our internal redeployment platform, we've moved more than 6,000 reskilled employees into new roles successfully to serve our clients' shifting needs. In the quarter, our people logged roughly 2.3 million training hours on Genome, our online demand learning platform; that figure covers our proprietary data and analytics certification program, which any of our global team members can take to sharpen their expertise at pulling critical insights from our huge operating data sets; this one-of-a-kind program remains a point of differentiation for us and was recently highlighted at the NASSCOM Business Innovation Showcase for how quickly it delivers upskilling and cross-skilling training; we've observed that team members who are active on Genome, and those who seize chances to move into different roles internally, show attrition at least 50% below the company average; that gives us an edge we pass along to clients, especially in the current macro environment, since our clients are themselves having a hard time locating the right talent. All year long, we've been working closely with clients to counter the effects of wage pressure and attrition that's higher than usual, using a mix of off-cycle pricing adjustments and non-FTE commercial models. We've moved ahead well on this effort, hitting the initial targets we laid out earlier in the year. Our performance so far this year underscores how resilient our business model is and the lasting competitive advantage we hold in the market. We think the bets we placed on our strategic choices over the years have left us well positioned to guide clients through the numerous difficulties in the macro environment. Pairing deep knowledge of both our sectors and our processes alongside digital tools and analytics has become still more pertinent right now for delivering value that lasts to clients. Central to all of this is how agile and nimble we are, letting us bring those various offerings to clients so we can join forces with them quickly and at scale; having said that, I'll now hand things over to Mike.

Thank you, Tiger, and hello everyone on the line this afternoon. I'll walk you through what we delivered in the third quarter, then provide an update on how we see the full year 2022 shaping up financially. We brought in total revenue of $1.111 billion, which marks a 9% rise compared to the same period a year ago, or 12% when you strip out currency fluctuations, and that landed right where we expected. Data-tech and AI Services made up 46% of total revenue. That segment expanded 19% year over year, and 21% when you strip out currency effects. The biggest driver was continued growth in cloud-based data and analytics offerings across the priority areas we've been focusing on, including supply chain, sales and commercial, and risk services. As for digital operations services, it represented 54% of overall top line and rose 2% compared with a year earlier, or 6% on a currency-adjusted basis. That increase came largely from deal ramps involving existing clients and ones we've recently onboarded. Turning to our performance across industry verticals: financial services saw an 18% increase versus the prior year. The main driver there is ongoing strong appetite for what we offer in risk management, coming from established banks as well as fintech companies, since both groups depend on data and analytics. In Consumer and Health care, we posted a 6% gain year-over-year, driven largely by engagements in data, tech and AI, along with sales and commercial and supply chain. Our high-tech and manufacturing segment, in the meantime, grew 16%, with the biggest contributions coming from sales and commercial, supply chain, and finance and accounting projects involving new clients and existing ones. As Tiger mentioned shortly before this, we are proceeding with our plan to divest the business that we classified as held for sale during the second quarter of this year. That shows up in the other operating expense line of our third quarter P&L, where we took a $21 million pretax charge tied to the anticipated net realizable value of that business. On an adjusted basis, operating income margin came in at 17.1%, 50 basis points higher than a year ago, driven largely by growth tied to operating leverage along with the effects of cost-containment steps we've taken recently. What we delivered this quarter reflects both the classification of that nonstrategic business as held for sale and the exclusion of the charge I just mentioned. Gross margins during the third quarter were 35.4%, down 20 basis points versus last year, yet they improved 100 basis points on a sequential basis over the second quarter. That quarter-on-quarter gain came mostly from stronger utilization amid sustained demand for our data tech and AI services, plus the upside of off-cycle pricing adjustments. Just to remind everyone, second quarter gross margin absorbed a negative 80 basis point hit from restructuring costs tied to strategic actions taken during that period. SG&A came in at 20.8% of revenue, 50 basis points below last year, mostly thanks to G&A leverage. Adjusted EPS reached $0.75, which is 14% higher than the $0.65 we posted in last year's third quarter; that $0.10 improvement came mainly from $0.08 of higher adjusted operating income, $0.02 from fewer shares outstanding and $0.01 tied to larger FX remeasurement gains booked this quarter versus the comparable period a year ago, partly offset by $0.02 of greater net interest expense and taxes. Our effective tax rate stood at 20.8%, versus 17.3% a year earlier. That climb was mostly attributable to the mix of smaller benefits recognized in the current year. Now shifting to cash flow and the balance sheet. In the quarter, operations produced $226 million in cash. That's versus $210 million during the comparable period a year ago. The gain came mainly from a stronger adjusted operating income margin along with a sequential improvement in DSOs, which went to 81 days from 84 days in the second quarter; because of clients' cash management practices while interest rates stay elevated, we now think we'll finish this year with DSOs in the low 80 range rather than the high 70s we initially anticipated. On the whole, the credit quality of our portfolio remains very strong and unchanged. Cash and cash equivalents came to $519 million, up from $460 million at the close of the second quarter of 2022. Over the trailing four quarters, the ratio of our net debt to EBITDA came in at 1.5x. With debt capacity we haven't drawn on plus the cash we already hold, we continue to have plenty of liquidity for chasing growth opportunities and executing our capital allocation strategy. We continue to expect that net debt-to-EBITDA will remain inside the 1x to 2x range we prefer. Given how the market looks right now, we're glad that close to 80% of our total debt is fixed-rate. Through the quarter, we maintained our practice of repurchasing shares on a more regular cadence, buying back about 627,000 shares, which cost us $30 million in total, at an average of $47.86 per share. Dividends we paid out came to $23 million. By the close of Q3, share buybacks had exceeded $180 million, matching the full-year 2022 guidance we shared earlier in the year. During the quarter, capex came in at roughly 1% of revenue. Because we're now getting better leverage out of a hybrid delivery approach, we expect that figure to land between 1% and 1.5% for all of 2022. Further out, as we expand facilities across different geographies, we foresee a return to the more typical 1% to 2% range. Let me now discuss the outlook for the entire year. With the U.S. continuing to show strength In terms of dollars, our projection for total revenue is now a range of $4.320 billion to $4.355 billion, which would reflect reported growth of 7.5% to 8.5% compared to last year. This figure accounts for an added currency headwind of $15 million beyond what we shared during last quarter's full-year outlook update. It also factors in $21 million in anticipated revenue tied to the business held for sale, a decrease from $28 million. On a constant currency basis, we're now looking at total revenue growth of 10% to 11%, whereas our full-year outlook for 2022 had been 9.5% to 11%. Our outlook for operating income margins for the whole of 2022 remains that they will land near the top of the 16% to 16.5% band we've given. Adjusted EPS for the full 2022 fiscal year is now guided to $2.69 to $2.74, compared with the earlier projection of $2.68 to $2.74. This updated outlook reflects a bigger currency headwind at the top end of our revenue guidance, along with somewhat higher net interest expense, both of which are offset by larger below-the-line FX remeasurement gains built up during the year so far. And lastly, given our revised DSO projection, we expect cash flow from operations across the full year to come in closer to $450 million. This reduced cash flow forecast is not tied to any softening in the business, since demand overall continues to be robust. With that, we hand the call back to Tiger.

Thanks, Mike. Whether we developed them in-house or brought them in via select acquisitions, the things we're capable of keep finding traction with customers. And because we can move fast, we're able to respond to what those customers need as it shifts. You can see that in how we've performed so far this year. Something that stands out to me: more and more, customers are looking to put their data to work throughout the business, generating richer insights and forecasts, which they then act on to get better results. Over 50,000 members of our digital operations group have finished the program to reskill them in data, and they're creating predictive models that improve what we deliver for clients. Just a handful of illustrations: in financial services, forecasting how likely a consumer is to pay. In consumer and health care, forecasting demand at different price and promotion points; and in Manufacturing and Hi-Tech, forecasting how satisfied customers will be, which lifts renewal rates for maintenance and SaaS offerings; we keep getting credit for what we're doing around ESG, and we're delighted that, for the second year in a row, we were just added to the Forbes List of World's Best Employers; Forbes has also once again named us one of America's Best Employers for Veterans, and we were cited as an exemplar of inclusion in the most inclusive companies index. Given where the macroeconomy stands right now, I'd like to express my gratitude to our more than 110,000 team members around the globe for staying dedicated to creating value for clients, communities and shareholders. Your grit, your resilience and your willingness to take on new challenges directly are what will make us succeed over the long haul. With that, I'll hand the call back to Roger.

Thanks, Tiger. At this point, we're ready to begin the question-and-answer portion of the call. Michelle, would you mind explaining the procedure for everyone?

Another strong quarter — well done.

Thanks, David.

Yeah. Yeah. Okay. And yeah, perhaps just as my question — or my initial question. So far this year, revenue has been really strong. I believe it's roughly 13% in constant currency, yet for the whole year, you're now indicating 11%. And if we sort of work backwards into Q4, it looks like mid-single digits or thereabouts in constant currency. And is that — is there something actually causing that? I realize you mentioned there's some splitting up into smaller portions of a few of the deals, but perhaps walk through a bit of that, if I'm understanding it correctly?

Yeah. So that's an excellent question, David; and let me begin by stating that on the whole, the quality of our pipeline stays really strong. What we've been observing, and we discussed this last quarter, and we keep observing this, is large transformational deals, I think clients are dividing them into a phased approach, mainly because I want quicker payback and I want speed, which is actually, interestingly, positive news, which is why the smaller and medium deals, the cycle times on those keep being really strong. When it comes to larger deals, especially from first-time outsourcers, they're taking longer; it demands buying from far more people. People are far more cautious about feedback and time and when do you pull the trigger. And we're seeing that play out in a very intriguing manner for our pipeline as we navigate this. But as I mentioned, many of those are getting split into medium-sized deals, and those are progressing very well. We also observed a churn in our pipeline on Data-tech-AI from growth-related agenda to cost-related agenda. And we've observed that, incidentally, across every industry segment. Very quickly, customers are refocusing back on cost, and that has produced a new set of pipelines, fresh, while a portion of the growth agenda has gone somewhat slower. So that churn decelerates as we cycle through in our pipeline and then return into the wait list.

Understood. Now, when we start thinking about next year, does the pipeline point to anything different at this point? In other words, does it currently look like it could back a fairly normal year across both segments? Or is it still a bit early to say, with churn making that harder to judge than it typically is?

Yes. So David, under ordinary circumstances, my answer would have been that it's too early to say. Given how the world looks right now, I'd definitely say it's too early to say. So I think we've got — once we reach the first quarter in February, when we report the full year results and discuss our full year outlook for 2023, I think our visibility will be much better. I think the world's visibility will be much better. As always, we're in the process of building that up from the ground up as a total plan, client by client, particularly beginning with our priority clients. Mike, would you like to add anything to that?

Sure. To add to your earlier point, Tiger, there are a couple of items. First, as Tiger mentioned, there’s a clear shift underway in our Data-Tech and AI business — moving away from a focus on expansion and toward one centered on expenses, which aligns perfectly with the current macroeconomic conditions. Also, remember that at any moment, our rolling forecast gives us roughly 70% visibility, correct? With that factored in, we’ll consolidate; as we carry out strategic planning for the coming year at the level of individual accounts, we’ll be able to share additional detail. That’s why we introduced Blueprint 2026, our organization’s long-range plan, which essentially sets a target of roughly 10% growth compared with the prior year. In any particular year it might be greater; for this year, our guidance ranges from 10% to 11%. So logically, it will be somewhat greater, and possibly next year it could be less or more; we’ll gain a bit more clarity on that, but is there anything worth highlighting from what you’re observing in Q4 as you construct that guidance from year-to-date 3Q through the full year?

Absolutely, David — and let me add a bit more on that, since in the markets we're operating in right now, this is likely a question that matters a great deal. What we've demonstrated over time, of course, is that whenever the world moves through what you might describe as a downturn at the macro level — the global financial crisis being one example, the pandemic another — we came through it quite strongly. It's true that growth on the whole might have declined for everybody, ourselves included, but what set us apart was the relative gap, and that gap was our advantage, since we didn't fall off the way other players did. That reflects both the nature of the services we offer and the variety and the sorts of clients we serve. So our confidence on that front remains intact. How the broader environment unfolds will become clear over the coming months, and my sense is that we'll see things more clearly once February arrives.

I'd like to ask a bit more about what you said regarding cash flow — specifically the rise in DSO as customers hold onto their money and so forth, in a climate where interstate rates are elevated. What I'm trying to get a handle on is how this situation develops, and what Genpact can potentially do to lessen the effects of customers taking longer to pay. Also, how actively are you collaborating with your clients to reach the optimal result for both sides? I just want a deeper understanding of how this trend is unfolding.

Sure. Let me start us off, and then others can chime in if they wish. Basically, the situation is that we're going back to a DSO pattern that's closer to what was typical for us in the past; a fair number of customers had been prepaying us or settling early, you know, and that pushed the figure lower and made our cash flow look more extreme. So at the time we issued our initial guidance, that was the assumption we modeled. We observed a meaningful shift in that conduct, likely somewhere between Q1 and Q2, as people grew far more conscious about managing their cash. What we're observing at present, then, is largely a return to the historical norm. As for how we engage our clients, every one of our contracts includes collection terms, T minus 30, 60, 90. We coordinate with them on payments along those lines; yet at a basic level, when I look at it on a rolling 5-quarter basis, we'll return to where we were. What I find more compelling, though, is the credit quality behind those collections, and that has simply been outstanding. It doesn't cause me any lost sleep whatsoever on that front.

Yeah. I'd say the main thing to take away from what Mike mentioned is that what we're seeing is our DSOs going back to the average, which was always how it worked before the pandemic; during the pandemic we actually picked up some gains from DSOs declining. Those gains have been handed back as we've made our way through this year.

Kate Kronstein here, filling in for Maggie. I'd like to ask a quick question regarding how attrition has gotten better, and could you all sort of explain what's behind that gain? Also, do you see it holding up over time?

Sure. Let me begin by noting that broader economic conditions matter in this. We mentioned before that the macro picture is starting to shift, and that came up during our last quarter; whether we look at the U.S., Europe, the Philippines, or India, the fact is that with many big corporations plus emerging ventures across tech, data, and analytics cutting back on their own recruiting, and that's before even mentioning businesses that have declared job cuts, we figured attrition would decline or begin to decline. As I noted during my prepared comments, it's too soon to claim success. We've observed a drop in attrition everywhere, across every region, every type of skill, and every tier. Even so, these figures remain above what they were before the pandemic. So looking ahead, you'd anticipate attrition would keep falling over the coming quarters, provided the work keeps moving through the cycle it's currently in. That's why we've focused on the right moves regarding talent, matching people to roles, reskilling, and ensuring our staff receive excellent chances to deliver value for clients and develop. Those approaches are ones we've long taken pride in; nonetheless, it's undeniable that the macro landscape has shifted over the past 90 to 120 days.