Genpact Limited (G) Earnings Call Transcript & Summary

Thanks, Dee Dee. Hello, everyone, and good afternoon. You're joining us for the earnings call for Q3, where we'll be talking about the results for the period that closed on September 30th, 2023. Hopefully you've had the opportunity to go through the earnings release we put up in the IR section on Genpact.com. On the line today we have Tiger Tyagarajan, who serves as our President and CEO, Mike Weiner, our Chief Financial Officer, and BK Kalra, who will be our next CEO. Here's how today's agenda looks: Tiger is going to give everyone an overview of how we did and bring you up to speed on our strategic initiatives. After that, BK will offer a few short introductory remarks, and then Mike will take you through the quarter's financial performance and also bring you up to date on what we expect for the full year 2023. Following that, Mike and Tiger will be available to answer your questions. We anticipate this call running roughly 60 minutes. A portion of what we'll be covering today is forward-looking and carries a variety of risks, uncertainties, and other factors that might lead actual results to come out materially different from what those forward-looking statements suggest. Those risks and uncertainties are laid out in our press release. Also, on this call we'll be citing certain non-GAAP financial measures, which we feel offer extra information that improves understanding of how management perceives the operating performance of our business. A direct reconciliation of those measures to GAAP is available in today's earnings release, which is posted in the IR section on our website. With all that said, I'll hand things over to Tiger.

Thanks, Roger. Hello, everyone, and I appreciate you being with us this afternoon for the call covering our results from the third quarter of 2023. I'm sure all of you have caught the great news that BK Kalra will take over as Genpact's incoming CEO, while I have shared that I'm retiring in February of 2024. I'll have more to say regarding that news, and BK will offer some remarks; but before that, let's go through the quarter. Broadly speaking, during quarter three we encountered mounting strain in short cycle advisory along with other project work, since clients stayed intensely concentrated on major transformation deals where lowering costs is the priority. That meant total revenue came in under what we had anticipated; even so, bookings continue to be robust and are tracking to expand by no less than 25% across 2023; on top of that, we keep achieving meaningful strides in how we use and deploy GenAI, moving into live production environments with results demonstrated early on. This is generating plenty of new inflows as clients get ready to embed large language models within their operations. Moving to a closer look at how we performed, on a constant currency basis we posted total revenue of $1.14 billion, a rise of 2% year-over-year, Data-Tech-AI Services revenue of $500 million, a decline of 2% year-over-year, and Digital Operations Services revenue of $636 million, an increase of 6% year-over-year; we likewise recorded adjusted operating income margin of 17.2%, which is 10 basis points higher year-over-year, along with adjusted diluted earnings per share of $0.76, up 1% year-over-year. Revenue during our third quarter expanded by less than we had anticipated. We experienced persistent strain across short cycle projects and advisory work, which came from three factors: one, a smaller number of small deals closed; two, decision cycles stretching out longer on those small deals; and three, softer appetite for smaller tech deals within our financial services and consumer healthcare verticals; these difficulties showed up mostly in our Data-Tech-AI Services, the area where we design and build solutions aimed at transforming our clients' businesses. That said, our recent large deal wins are ramping up right on schedule; this supported solid results in our Digital Operations Services, the area where we digitally transform and run our clients' operations. Considering how we've performed so far this year, reduced visibility compared with normal into client discretionary spending, and no expectation of the usual seasonal year-end lift that comes from budget flush spending, we are resetting our revenue outlook for the full year 2023; we now anticipate full-year top line growth of roughly 2.5% year-over-year on a constant currency basis, against our earlier expectation of 5.5%-6.5% growth. Mike is going to walk through this revised outlook in greater detail. Even with the difficult macro backdrop, appetite for our long-term annuity-based services stays quite healthy. Driven by inflows that remain strong, our high-quality pipeline hit a record level yet again. We think our deep domain process and data expertise, paired with our experience building, developing, and refining our AI capabilities across the last seven years, hands us a distinctive competitive edge in these times as GenAI rises. That has brought in lots of new deal inflows so far this year, with GenAI embedded. During the quarter, we closed 2 new major contracts, which came after the 11 we had secured in the first half of the year. Our win rates for the period came in at about 55% higher than what we've seen historically, and close to 50% of those wins were still sole source. On top of that, we brought in 32 new logos this quarter, which represents a recovery from where we were in the first half. With bookings expected to grow for the full year and our pipeline continuing to expand, we remain confident that we're positioned well for accelerating growth in 2024 relative to our adjusted outlook for 2023. That said, because visibility into our short cycle revenue is limited, we don't right now have the same confidence we had in our prior quarter update when it comes to forecasting a return to double-digit growth in 2024. We'll share a more detailed 2024 outlook on our year-end earnings call in early February. Now, on to our 5 key strategic initiatives — we kept making headway on all of them in quarter three. First, revenue from our priority accounts rose 6% year-over-year in the quarter and grew to roughly 64% of our total revenue. The money we're putting into these clients is paying off, since about 70% of our year-to-date bookings came from our priority accounts. Over the long term, we still expect this portfolio to grow faster than the company average. Second, we keep strengthening our partnerships with cloud technology players as we co-innovate and build joint IP solutions. Three examples. First, we broadened our partnership with AWS, bringing their Bedrock GenAI capabilities together with our proprietary cloud-based financial crime solution. That solution has gone into production at 2 financial institutions to drive precision and efficiency in detecting, investigating, and preventing financial crime. We added to our team and certifications in GenAI, machine learning, and data engineering for Google Cloud, and new SaaS solutions listed on the Google Cloud Platform Marketplace. And finally, as an elite partner of ServiceNow, we're enhancing our cloud-based joint solutions that automate procurement and sourcing, supply chain, and insurance processes, just to name a few. Third initiative, we're continuing to put money into new operating centers in tier three cities in India, where we grew both our talent base and footprint. These new hubs give us not only cost benefits, but also access to diverse talent pools with lower attrition. Fourth, we keep pushing outcome and transaction-based commercial models, which made up 16% of our revenue in the third quarter. And finally, our recent investments in large deal team keep producing great results in both bookings and pipeline. As expected, our attrition level for the third quarter was 25%, in line with the first half of the year and well below the 36% during the same period last year. If we adjust for involuntary attrition and employees with less than three months of service, our attrition rate was even lower at 21%. Let me now update you on the rapid progress we are making with GenAI. My conviction has only grown that we're looking at an enormous opportunity here. There are 3 areas where we're concentrating. First, GenAI is being deployed by us to shake up segments where penetration is lower and which are completely open to fresh service models. Customer care is one instance, as are FP&A, sales, and commercial operations. Second, we're putting priority on services in which we're acknowledged as a leader. Financial accounting is an example, along with financial crimes and risk services, plus supply chain, and in these GenAI works as a catalyst producing a step function gain in outcomes. Third, GenAI is being rolled out by us internally throughout our own HR, training, knowledge management, and software development functions, which helps generate speed, better margins, and an improved experience for employees and users; right now we have over 90 distinct GenAI solutions going through rigorous testing, whether with clients or with our internal teams; our focus has started moving away from creating proof of concept and pilots toward putting solutions into live production environments, with roughly 10 either deployed or in the process of going live. So far, we've held close to 2,000 client conversations, which has helped produce GenAI roadmaps featuring specific use cases and the related execution paths. Although the financial crimes solution running on Amazon Bedrock was already covered by me earlier in the call, allow me to now offer 2 additional examples that are moving quickly toward production.

When it comes to a worldwide entertainment firm, we brought AI into the mining and sentiment analysis of their customer chat data. The result was a 40% cut in the resources needed to handle chat feedback, plus a substantial lift in first-time resolution by giving service agents optimal responses to resolve customer problems; for a top financial organization, we incorporated GenAI, predictive AI, and machine learning models into their loan review workflow, which produced a 3-time rise in the volume processed. This shift is boosting client satisfaction and fueling business growth. Although it's still early, solutions with GenAI built in let clients reach outcomes fast. Consequently, we think it will speed up the movement toward more widespread adoption of alternate commercial pricing models, which in the long run should further separate revenue growth from employee growth. Our capacity to upskill our people at scale, paired with our deep domain knowledge, gives us a competitive edge as we assist clients in capturing what GenAI offers. Right now, over 90,000 team members have signed up for our AI training programs, and nearly 47,000 of them have finished certifications at various levels. We've also set up an internal AI Playground so our employees can try out multiple large language models, which helps push GenAI adoption. At present, over 60,000 employees are on this platform. The top industry analyst firm, HFS, recently acknowledged our progress, and we received the highest ranking in their inaugural Generative Enterprise Services Horizon report. Now, allow me to return to the CEO succession plan that we made public today. Leading Genpact for the past 12+ years has been an amazing journey for me. During that period, the world has shifted enormously, and Genpact has effectively reinvented itself alongside it. I hold immense personal and professional admiration for BK. For years he has been a genuine partner to me and has helped shape and carry out the company's many pivots. No one understands our business, our clients, and our teams better than he does, and he represents the finest of who we are at Genpact. His comprehensive, hands-on style of strategic and operational leadership will serve as a guiding force when he takes over as our next CEO. Just as importantly, we've assembled a terrific leadership team through the years, which will ensure the entire transition goes smoothly. As for myself, I intend to remain actively engaged as a board member and will naturally collaborate very closely with BK to guarantee a smooth and successful transition. With that, I'd like to hand things over to BK for a few additional remarks.

Thanks, Tiger. Being chosen to serve as Genpact's incoming CEO feels like a real privilege, and speaking for everyone at Genpact, we want to say how deeply grateful we are for the way you've led us. Lots of you already know that I joined Genpact back in our earliest days. It's a pleasure to take the reins of such a gifted group and to keep building atop the solid base Tiger has put in place. I can't wait to move into the CEO seat early next year. During the coming months, I'll be examining all parts of the operation and making time to hear from our clients, employees, partners, and investors. What matters most for us at this moment is steering through today's macro conditions. I have no doubt the headwinds will pass and that our business model is still strong. We anticipate our top line getting better in 2024. We play in a market that is under-penetrated and growing fast, and thanks to the unmatched commitment of our worldwide team, we're in a superb position to generate sustainable long-term growth for every one of our key stakeholders. So with that, I'll hand things over to Mike, who will walk through the quarter in greater detail.

Thanks, BK, and good afternoon, everyone. I'll go over what we delivered in the third quarter today, and then share our current view on the full year 2023 outlook. We brought in total revenue of $1.136 billion, which rose 2% from a year earlier, on both an as-reported and constant-currency basis. Data-Tech-AI Services revenue made up 44% of total revenue and fell 2%, again on both an as-reported and constant-currency basis. That result came in under what we had expected, mainly because of added pressure tied to short-cycle, discretionary tech spending that ramped up during September across both our financial services and consumer and healthcare verticals. Digital Operations Services revenue accounted for 56% of total revenue and was up 6% from a year earlier, on both an as-reported and constant-currency basis, driven by on-time deal ramps from large bookings we won recently. Looking at it by vertical, financial services rose 6% from a year earlier, mostly on large deal ramps, partially offset by clients spending less on discretionary tech than we had anticipated. Consumer and healthcare fell 2% from a year earlier, mostly because of pressure on short-cycle, growth-oriented digital marketing projects and discretionary tech spending, plus the effect of the recent divestiture of a business we had classified as held for sale last year. High-tech and manufacturing rose 4% from a year earlier, mainly from ramp-ups tied to recent new and large logo wins, partially offset by a reduction in scope with a priority high-tech client that we mentioned earlier in the year. Even with our disappointing third quarter top-line performance, over the 12 month period ending September 30th, 2023, we increased the count of client relationships generating annual revenue above $5 million, from 158 to 182. On top of that, clients with annual revenue above $25 million grew from 34 to 38, and clients above $100 million went from 3 to 5. Adjusted Operating Income Margin came in at 17.2%, which was up 10 basis points from a year earlier and up 40 basis points from the prior quarter, mostly on higher gross margins and general operational efficiencies. As a reminder, our third quarter performance a year ago benefited from the business designated as held for sale last year, which has since been divested. Gross margins in the third quarter widened 10 basis points from a year earlier, mainly reflecting cost management actions we took earlier in the year. On a sequential basis, gross margins improved 20 basis points, mostly from better utilization and a greater mix of Digital Operations revenue, offset by the effect of ramping up large deal wins we landed recently. SG&A as a percentage of revenue improved 60 basis points, both from a year earlier and from the prior quarter, coming in at approximately 20%. The year-over-year improvement came mostly from the absence of expenses tied to the non-strategic business that was divested, which offset higher investment in sales and marketing and research and development during the third quarter of 2023. The sequential improvement from the second quarter was mainly from operating leverage. Our effective tax rate was 24.1% versus 20.8% last year, mostly because of changes in our jurisdictional mix of income and a recent increase in U.K. statutory income tax rates. On an adjusted basis, earnings per share came in at $0.76. That's a 1% improvement versus a year ago, when we posted $0.75 in the third quarter. What drove that? Mostly a $0.02 lift from higher adjusted operating income, plus a $0.01 benefit tied to a reduced share count outstanding. Those gains were partly canceled out by a $0.02 hit from our effective tax rate rising compared with a year earlier. Now moving on to cash flow and the balance sheet. This quarter, operations brought in $162 million of cash. In the comparable quarter a year ago, that figure stood at $226 million. The reason for the drop was a sequential rise in our DSOs during Q3, tied to collections arriving later than expected on some accounts, with that cash coming in during early October. Looking year over year, DSOs were up by three days, landing at 84 days. Our current expectation is that we'll finish the year around that same level. Net debt to EBITDA, measured across the trailing four quarters, came to 1.1 x. When it comes to capital expenditures, that worked out to roughly 1.3% of revenue. Now I'd like to walk you through our updated view on the full-year outlook. As Tiger mentioned previously, during Q3 we observed clients growing more hesitant about spending on discretionary projects. That fed through into short-cycle project revenue coming in below what we had expected. Meanwhile, we kept our focus on putting priority on big transformational deals that are motivated by saving costs and gaining efficiency. Because of this dynamic, near-term revenue was reduced, since bookings stayed weighted toward large deals whose revenue gets recognized across a multiyear stretch. Consequently, our expectation for 2023 full-year revenue is now roughly $4.45 billion. That works out to 2.5% growth compared with last year, on a constant currency basis. For the full year, we now anticipate our adjusted operating income margin expanding 50 basis points versus a year ago, reaching 17%. That's an improvement over the 16.8% we had previously guided. The main reason for the bump is a richer mix of Digital Operations revenue within our revised top-line outlook, along with reduced investment aimed at growing Data-Tech-AI Services revenue over the rest of the year. We anticipate that our recent large deal bookings will deliver more revenue in Q4 than they did in Q3. Since a number of these deals begin with onshore delivery, our expectation for full-year 2023 gross margin remains relatively flat to slightly down against last year. After factoring in our tax expense so far this year, we now anticipate the 2023 full-year effective tax rate will land at the lower end of our 24%-25% range. With this updated outlook, we now expect full-year 2023 adjusted earnings per share of roughly $2.89. That represents 6% growth compared with last year. Because of the DSOs we anticipate and the lower adjusted operating income we expect, we now project full-year cash flow from operations of about $475 million. Our previous outlook had been approximately $500 million. For the full year, we now expect capital expenditures as a percentage of total revenue to come in at the low end of our 1.5%-2% range. Like Tiger mentioned, because we can see so little when it comes to short cycle revenue, our confidence in predicting double-digit growth for 2024 isn't as strong as it was during last quarter's call. Even so, we still think we're in a good spot for growth to speed up in 2024. In the coming weeks, we'll wrap up our forecast and give you detailed 2024 guidance on a year-end earnings call in early February. Having said that, I'll hand the call back over to Roger.

Thanks, Mike. At this point, we want to start the Q&A portion of the call and take whatever you'd like to ask. Dee Dee, would you mind walking everyone through how to participate?

Hi there, thanks so much. Wow, Tiger, what a great journey it has been, so hearing that this era wraps up come February feels strange, but congratulations on that announcement and, naturally, congratulations to BK as well. Perhaps, yes, we will — I'm certain there will be another opportunity to talk, I suppose, during this quarter too; but let's just dive into the business for a moment. When I think about what's been said regarding short cycle plus large deals, that's been quite a frequent theme, Tiger, that has come up across this earnings season. So perhaps could you share a bit about ACV compared with TCV? I've been attempting to grasp that interplay more clearly across many of the companies. I would really like to hear what you think about it, since it seems the backlog is solid, yet the short cycle activity isn't filling in. So that has to be affecting how much of the bookings convert this year or in year. So is there anything to take us through that interplay?

Tien, to start, I appreciate it. Your question basically answered itself. What you described is precisely the pattern we're observing. We're seeing really robust long-cycle annuity agreements that carry multi-year TCV. As you're aware, in our line of work, those usually fall somewhere around three years to a bit more than three years on average — in reality, nearer to four years. Meanwhile, on the shorter-cycle side, you might see 3 months, six months, nine months, 1 year, and so on. It's those shorter, near-term projects that have come under pressure, and that's something we've been hearing about throughout the industry. ... Actually, both of those forces are present across the industry. What happens next is we're looking at that 25%, at minimum bookings growth we referenced, and that creates a solid setup, especially for Digital Operations, and equally for half of our Data-Tech-AI, since half of our Data-Tech-AI is long-cycle by its nature. It positions us well for the extended run. Shorter-term bookings that aren't closed right away mean revenue impact that won't materialize during the year. That's the pattern we're seeing. Mike, would you like to add something?

Sure, here's what I'd put on top of that. If you really follow through on the point you just made, Tiger, about bookings being projected to rise 25% year-over-year, and how that shows up in the third quarter financials and in how we're viewing the fourth quarter too — our Digital Operations business was up 6%, or we expect it to keep growing, and most of the large deals were captured there, plus, as you mentioned before, roughly half of the Data-Tech- AI business sits there. So as you said when you opened things up, it's a tale of two cities: hugely strong transformational large deal wins that account for most of the pipeline, alongside some nearer-term, non-annuity Data-Tech- AI pressure that we're seeing in the third quarter and expect to continue into the fourth.

Alright, I appreciate you walking us through all of that. Now, let me just ask a quick follow-up. So there’s no assumption of a budget flush this year — that makes sense. I did hear what was said regarding 2024 and the pickup in 2025, but what exactly are you expecting? Is there anything you could possibly do to spark the short-cycle business, other than adjusting price? I mean, I suppose shifting things around the calendar year can sometimes be helpful, though at this point it’s likely too soon to say. Is there anything on your end that might be done to help ignite that?

Okay, so here's how we're sort of looking at things, and we're not going to give out any specific figures today for 2024 or talk about how we see the year starting off. There are several important factors we consider in our business. Naturally, the foundation of it — with Digital Operations growing solidly — will serve as a core base for us, given those big deal signings we had, including the 2 we closed in this quarter. But honestly, the thing that moves, the fluctuation, that really stems from our Data-Tech- AI business that we discussed earlier. Just a handful of quick points. The pipeline in Data-Tech- AI is still unbelievably robust and expanding, which tells you there's enormous demand out there. Those big deals I brought up before also contain a Data-Tech- AI element to them, and those will keep ramping up throughout next year; but more precisely, what might we accomplish and what are we observing at this moment? Well, there's an enormous opportunity tied to generative AI. To be specific, although we didn't witness the budget flushing we normally see in the third and especially heading into the fourth quarter, we aren't picking up on any deterioration when it comes to generative AI budgets as we head into next year; so as we see it, those dollars are what we're going to pursue; with our enormous emphasis and investment in data engineering solutions, I believe that's going to be a helpful tailwind for us as we move forward, especially in the Data-Tech- AI area, to help push our growth next year beyond the level we achieved this year, without a doubt.

And to wrap up on top of what Mike mentioned, regarding a few of the concrete steps we've already put in place, we currently offer a GenAI suite of solutions built on those 90 projects and pilots I referenced, with 10 of them moving ever closer to production status and 2 fully in production. The further this advances, the more we shift into replication mode, and as you'd expect, with GenAI, when you can replicate and begin rolling those solutions out, they get adopted quite rapidly. So we see that as a tailwind. Next, generative AI by its very nature raises the question for our clients about whether their data is fully in order, and that's where Mike's point about data engineering becomes really significant. We anticipate data engineering will be among the tailwinds for our Data-Tech-AI as we wrap up this year and head into the next; those concrete steps involve directing resources toward the particular buying centers, industry verticals, and geographies where we foresee the greatest gains.

Thanks for walking through that.

Absolutely.

Thanks. I was hoping you might be able to say a bit about this. It's really nice that you consistently share that non-FTE percentage figure. Could you shed some light on how that non-FTE work is gaining momentum inside your high priority accounts, and how broadly it's being taken up across those specific accounts?

Maggie, that's actually a terrific question. Looking at total revenue, the penetration for our non-FTE commercial models stands at 16%, which you heard mentioned in my remarks. And as you'll recall, we had stated that by the long-term 2026 horizon, we want to reach at least 20%; and during the last quarter, I said again that there's a very strong likelihood we'll arrive there sooner, since our bookings appear to be tracking at a penetration level for alternate commercial models above that 16%, which is excellent, and so it will keep building. When it comes to priority accounts, the penetration of non-FTE pricing models is above the company average. I couldn't provide the precise figure off the top of my head, but it is. It's running above the company average, and the explanation is quite straightforward. Frequently in the smaller relationships, you lack sufficient combined scale to generate the sort of non-FTE pricing and value-based pricing that becomes possible when you handle financial accounting alongside order management and supply chain. Once you bring all of that together, our capacity to create real value is enormous, and we share in that value creation.

Thanks; and regarding margins, do you expect the present situation — short cycle work compared with those longer-term cost optimization projects — will affect where gross margin or operating margin lands across the coming 2 quarters?

Right, and, you see, there are 2 distinct forces at play tied to our gross margin. As you're aware, whenever we see those big deal ramp-ups, especially when onshore delivery gets taken on and shifted offshore, that usually dilutes the business near term, and from a gross margin standpoint it becomes accretive. There's also an opposing angle to consider, which is that when revenue growth slows, our Data-Tech- AI gross margins help us disproportionately on a gross margin basis. So having said that, and given our projections heading into next year with Data-Tech- AI recovering, I believe they'd be fairly flat going forward, with those 2 opposing factors pulling in different directions.

Understood. Thanks. Also, congratulations to you, Tiger and BK, regarding what you announced.

Thanks, Maggie.

Hi everyone. Tiger, congrats on such a lengthy tenure, and collaborating with you has truly been a joy. And BK, congratulations — thoroughly earned — and I'm eager to be working alongside you.