Genpact Limited (NYSE:G) Q3 2023 Earnings Call Transcript

Genpact Limited (NYSE:G) Q3 2023 Earnings Call Transcript November 8, 2023

Genpact Limited beats earnings expectations. Reported EPS is $0.76, expectations were $0.74.

Operator: Good day, ladies and gentlemen. Welcome to the 2023 Third Quarter Genpact Limited Earnings Conference Call. My name is Dee Dee [ph], and I will be your conference moderator for today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session toward the end of this conference call. As a reminder, this call is being recorded for replay purposes. The replay of the call will be archived and made available on the IR section of Genpact’s website. I would now like to turn the call over to Roger Sachs, Head of Investor Relations at Genpact. Please proceed.

Roger Sachs: Thank you, Dee Dee. Good afternoon, everybody, and welcome to our third quarter earnings call to discuss results for the period ended September 30, 2023. We hope you had a chance to review our earnings release, which was posted to the IR section of our website, genpact.com. Speakers on today’s call are Tiger Tyagarajan, our President and CEO; Mike Weiner, our Chief Financial Officer; and BK Kalra, our next CEO. Today’s agenda will be as follows: Tiger will provide an overview of our results and update you on our strategic initiatives. BK will follow with a few brief introductory comments. And Mike will walk you through our financial performance for the quarter as well as update you on our full year 2023 outlook.

Mike and Tiger will then take your questions. We expect the call to last about an hour. Some of the matters we will discuss in today’s call 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. Such risks and uncertainties are set forth in our press release. In addition, during today’s call, we will refer to a 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. You can find the reconciliation of these measures to GAAP in today’s earnings release posted to the IR section of our website.

And with that, let me turn the call over to Tiger.

Tiger Tyagarajan: Thank you, Roger. Good afternoon, everyone, and thank you for joining us today for our third quarter 2023 earnings call. I know you’ve all seen the exciting news that BK Kalra has been appointed as Genpact’s next CEO. As I’ve announced my retirement in February of 2024. I will share more about this announcement and BK will share a few words. But first, let’s review the quarter. At a high level, we saw increasing pressure in short cycle advisory and other project work in quarter three as clients remained sharply focused on large transformational deals that prioritize cost reductions. This resulted in total revenue being below our expectations. However, bookings remain strong and are on pace to grow at least 25% in 2023.

In addition, we continue to make significant progress in the use and deployment of gen AI as we move into live production environments with early demonstrated results. This is leading to many new inflows as clients prepare to embed large language models into their operations. Turning to our performance in more detail. We delivered on a constant currency basis total revenue of $1.14 billion, up 2% year-over-year. Data-Tech-AI services revenue of $500 million, down 2% year-over-year and Digital Operations services revenue of $636 million, up 6% year-over-year. We also delivered adjusted operating income margin of 17.2%, up 10 basis points year-over-year, and adjusted diluted earnings per share of $0.76, up 1% year-over-year. Our third quarter revenue grew less than expected.

We saw ongoing pressure in short cycle projects and advisory work, driven by three things; one, fewer small deals converted; two, longer decision cycle times for those small deals; and three, lower demand for smaller tech deals in our financial services and consumer healthcare verticals. These challenges were predominantly felt in our Data-Tech-AI services, where we design and build solutions to transform our clients businesses. However, our recent large deal wins are ramping up on schedule. This helps drive solid performance in our Digital Operations services where we digitally transform and run our clients operations. Given our year-to-date performance, lower than normal visibility into client discretionary spending and no expectation of seeing the typical seasonal year-end lift from budget flush spending, we are resetting our full year 2023 revenue outlook.

We now expect full year top line growth of approximately 2.5% year-over-year on a constant currency basis compared to our prior expectation of 5.5% to 6.5% growth. Mike will provide greater details on this updated outlook. Despite the challenging macro environment, demand for our long-term annuity based services remains very healthy. Fueled by continued robust inflows, our high quality pipeline once again reached a record level. We believe our deep domain process and data expertise, combined with our experience building, developing, and refining our AI capabilities over the last seven years gives us a unique competitive advantage in these times with the rise of gen AI. This has led to many new deal inflows year-to-date embedded with gen AI.

We signed two new large deals during the quarter following the 11 we signed in the first half of the year. Win rates in the period were approximately 55% above historical levels and roughly half of our wins continued to be sole sourced. We also added 32 new logos during the quarter, a bounce back from the first half of the year. With anticipated growth in bookings for the year and ongoing expansion of our pipeline, we continue to believe that we are well-positioned for accelerating growth in 2024 compared to our adjusted outlook for 2023. However, given limited visibility into our short cycle revenue, we currently do not have the same level of confidence in forecasting a return to double-digit growth in 2024 as we did in our prior quarter update.

We will provide a more detailed 2024 outlook during our year-end earnings call in early February. Turning to our five key strategic initiatives we continue to make progress in all of them in quarter three. First, revenue from our priority accounts grew 6% year-over-year during the quarter and expanded to approximately 64% of our total revenue. Our investments in these clients are paying off as approximately 70% of our year-to-date bookings were from our priority accounts. We continue to expect this portfolio to grow faster than the company average over the long-term. Second, we continue to deepen our partnerships with cloud technology players as we co-innovate and create joint IP solutions. Three examples, first, we expanded our partnership with AWS, integrating their Bedrock gen AI capabilities with our proprietary cloud-based financial crime solution.

This solution has been deployed into production at two financial institutions to drive precision and efficiency in detecting, investigating, and preventing financial crime. We grew our team and certifications in gen AI, 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 are enhancing our cloud-based joint solutions that automate procurement and sourcing, supply chain, and insurance processes, just to name a few. Third initiative, we are continuing to invest in new operating centers in Tier 3 cities in India, where we expanded our talent base and footprint. These new hubs not only offer us cost benefits, but also access to diverse talent pools with lower attrition.

Fourth, we continue to drive outcome and transaction based commercial models, which represented 16% of our revenue in the third quarter. And finally, our recent investments in large deal team continue to generate great results both in bookings and pipeline. As expected, our attrition level for the third quarter was 25%, consistent with the first half of the year and significantly lower than the 36% during the same period last year. Adjusting 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 gen AI. I’m more confident than ever that this is a huge opportunity for us. We have three focus areas. First, we are using gen AI to disrupt less penetrated areas for us that are wide open for new service models, for example, customer care, FP&A, sales and commercial operations.

Second, we are prioritizing services where we are a recognized leader, for example, financial accounting, financial crimes and risk services, and supply chain where gen AI acts as a catalyst to drive a step function improvement in outcomes. And third, we are implementing gen AI internally across our own HR training, knowledge management and software development functions, helping to drive speed, margin improvement and employee and user experience. We currently have more than 90 specific gen AI solutions that are undergoing rigorous testing either with clients or our internal teams. We have begun to shift our focus from building proof of concept and pilots to implementing solutions in live production environments with about 10 either deployed or on the verge of going live.

To date, we’ve had nearly 2,000 client conversations helping to generate gen AI roadmaps with specific use cases and related execution parts. While I already shared the financial crime solution deployed on Amazon Bedrock earlier in the call, let me now share two more examples that are on a rapid path to production. For a global entertainment company, we’ve integrated AI into mining and sentiment analysis of their customer chat data. This has led to a 40% reduction in resources for handling chat feedback as well as a significant increase in first time resolution by providing ideal responses to service agents to solve customers’ issues. For a leading financial institution, we integrated Gen AI, predictive AI and machine learning models into their loan review process, resulting in a 3-time increase in volume processed.

This transformation is enhancing client satisfaction and driving business growth. While we are still in the early days, Gen AI embedded solutions enable clients to quickly achieve outcomes. As a result, we believe it will help accelerate the trend towards greater use of alternate commercial pricing models, ultimately leading to a greater decoupling of revenue growth from employee growth over the long-term. Our ability to upskill our employees at scale combined with our deep domain expertise represents a competitive advantage for us as we help clients unlock the benefits of Gen AI. We now have more than 90,000 team members enrolled in our AI training programs with almost 47,000 having completed various levels of certifications. We have also created an internal AI playground where our employees can experiment with multiple large language models to help drive Gen AI adoption.

Currently, more than 60,000 employees are using this platform. Our progress was recently recognized by the leading industry analyst firm HFS, where we earned the highest ranking in their inaugural Generative Enterprise Services Horizon report. Now, let me come back to the CEO succession plan we announced today. It has been an incredible journey for me leading Genpact over the last 12 plus years. The world around us has changed dramatically in that time and Genpact has successfully transformed along with it. I have tremendous personal and professional respect for BK. He has been a true partner for me for years and helped shape and execute the various pivots of the company. He knows our business, our clients and our teams better than anyone and embodies the very best of who we are at Genpact.

His holistic and hands on approach to strategic and operational leadership will be a guiding force as he becomes our next CEO. Equally importantly, we’ve built a great leadership team over the years that will make the whole transition seamless. As for me, I plan to stay actively involved as a member of the Board and will of course work very closely with BK to ensure a smooth and successful transition. With that, I’d like to turn it over to BK for a few additional remarks.

BK Kalra: Thank you, Tiger. I consider it an honor to be selected as Genpact’s next CEO, and on behalf of the entire Genpact team. I want to express our immense gratitude for your leadership. As many of you know, I have been with Genpact since our early days. I look forward to leading this talented team and building on the strong foundation that Tiger has established. I’m excited to step into the CEO role early next year. Over the next several months, I’ll be reviewing every aspect of the business and spending time listening to our clients, employees, partners and investors. The focus for us right now is navigating the current macro environment. I’m confident the headwinds are temporary and our business model remains robust.

We expect to see our top line improve in 2024. We participate in underpenetrated and high growth market and with unparalleled dedication of our global team, we are extremely well positioned to drive sustainable long-term growth for all our key stakeholders. With that, let me turn the call over to Mike to go over the quarter in more detail.

Mike Weiner: Thank you, BK, and good afternoon, everyone. Today, I’ll review our third quarter results and provide you with our latest thinking regarding our full year 2023 outlook. Total revenue of $1.136 billion was up 2% year-over-year, both as a reported and as a constant currency basis. DataTech and AI services revenue, which represents 44% of total revenue, declined 2% both on an as reported and a constant currency basis. This performance was below our expectations, largely due to incremental pressure related to short cycle discretionary tech spending that escalated during September for both their financial services and consumer and healthcare verticals. Digital Operations services revenue which represents 56% of total revenue, increased 6% year-over-year, both on an as reported basis and a constant currency basis, reflecting on time deal ramps related to recent large booking wins.

From a vertical perspective, financial services increased 6% year-over-year, largely due to large deal ramps, partly offset by clients lower than expected discretionary tech spending. Consumer and healthcare declined 2% year-over-year, largely due to pressure on short cycle growth oriented digital marketing projects and discretionary tech spending, as well as the impact from the recent divestiture of a business we had previously classified as held for sale last year. High tech and manufacturing increased 4% year-over-year, primarily driven by ramp ups related to recent new logo wins, partly offset by the impact of reduction of scope of a priority high tech client mentioned earlier in the year. Despite our disappointing third quarter top line performance, during the 12-month period ending September 30, 2023, we grew the number of client relationships with annual revenue greater than $5 million from 158 to 182.

Additionally, clients with annual revenue greater than $25 million expanded from 34 to 38 and clients more than 100 million increased from 3 to 5. Adjusted operating income margin was 17.2%, up 10 basis points year-over-year and 40 basis points sequentially, largely due to higher gross margins and general operational efficiencies. As a reminder, our performance in the third quarter last year included the positive impact from the business designated as held for sale last year that has been divested. Gross margins in the third quarter expanded 10 basis points year-over-year, primarily reflecting cost management actions implemented earlier in the year. Sequentially, gross margins improved 20 basis points, largely driven by better utilization and greater mix of digital operations revenue offset by the impact of ramping up of recent large deal wins.

SG&A as percentage of revenue improved 60 basis points both year-over-year and sequentially, reaching approximately 20%. Year-over-year improvement was largely due to the absence of expenses related to non-strategic business that was divested, offsetting the higher investment in sales and marketing and research and development in the third quarter of 2023. Sequential improvement from second quarter was primarily due to operating leverage. Our effective tax rate was 24.1% compared to 20.8% last year, largely due to changes in our jurisdictional mix of income and a recent increase in UK statutory income tax rates. Adjusted EPS was $0.76, up 1% year-over-year from $0.75 during the third quarter of last year. The increase was primarily driven by higher adjusted operating income of $0.02, the positive impact from lower outstanding share count of $0.01, partly offset by $0.02 impact from year-over-year increases in our effective tax rate.

Turning to cash flow and balance sheet. During the quarter, we generated $162 million of cash from operations compared to $226 million during the same period last year. The decline was driven by sequential increase in our DSOs in the third quarter related to delayed collections on certain accounts where cash was received in early October. On a year-over-year basis, DSOs expanded by three days to 84 days. We now expect the end of year to be at a similar level. Our net debt to EBITDA ratio the last four rolling quarters was 1.1 times. Capital expenditures as percentage of revenue equated to approximately 1.3%. Now, let me provide you with our latest thinking regarding our full year outlook. As Tiger discussed earlier, we saw clients become more cautious on discretionary project spending during the third quarter.

This translated into lower levels of short cycle project revenue than we anticipated. At the same time, we remained focused on prioritizing large transformational deals driven by cost savings and efficiency gains. This dynamic resulted in less near-term revenue as bookings remain skewed towards large deals where revenue is recognized over a multiyear period. As a result, we now expect revenue for full year 2023 to be approximately $4.45 billion, representing a year-over-year growth of 2.5% on a constant currency basis. We now anticipate our full year adjusted operating income margin to expand by 50 basis points year-over-year to 17%. This is up from our prior outlook, up 16.8%. The increase is primarily driven by the greater mix of digital operations revenue in our revised top line outlook as well as lower investment in DataTech and AI services revenue growth for the remainder of the year.

We expect of recent large deal bookings to contribute to higher revenue in the fourth quarter compared to the third quarter. Given that many of these deals have initial onshore delivery, we continue to expect full year 2023 gross margin to be relatively flat to slightly down compared to last year. Taking into account, our year-to-date tax expense, we now expect full year 2023 effective tax rate to be at the lower end of our 24% to 25% range. Given the updated outlook, we now expect adjusted earnings per share for the full year 2023 to be approximately $2.89, representing year over year growth of 6%. Due to the anticipated DSOs and lower expected adjusted operating income, we now expect to generate full year cash flow from operations of approximately $475 million compared to our prior outlook of approximately $500 million.

We now expect capital expenditures as percentage of total revenue to be at the low end of our 1.5% to 2% range full year. As Tiger discussed, given our limited visibility and short cycle revenue, we do not have the same level of confidence in calling for a double digit growth in 2024 as we did when we spoke to you last quarter. That said, we continue to believe we’re well positioned for accelerating growth in 2024. Over the next several weeks, we’ll be finalizing our forecast and provide you with specific 2024 guidance during a year-end earnings call in early February. With that said, let me turn the call back to Roger.

Roger Sachs: Thank you, Mike. We’d now like to open up our call for your questions. Dee Dee, can you please provide the instructions?

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Q&A Session

Operator: Thank you. [Operator Instructions] And our first question comes from Tien-Tsin Huang of J.P. Morgan.

Tien-Tsin Huang: Hey, thank you. Wow, Tiger, it’s been an amazing run. So it’s weird to hear that end of an era here come February, but congrats on that news. And of course, congrats to BK. Well, I’m sure we’ll get a chance to speak again next quarter as well. But let’s just get into the business for a second here. Just thinking about the comments around short cycle as well as large deals, it’s been a pretty common theme, Tiger, that we’ve been hearing throughout this resort season. So maybe can you talk a little bit about ACV versus TCV? I’ve been trying to understand that dynamic better for a lot of the companies. I’d love to hear your thoughts on that because it sounds like the backlog is strong, but the short cycle work isn’t filling out. So that must be having an impact on the level of bookings that convert this year or in year, so anything to walk us through that dynamic.

Tiger Tyagarajan: So, Tien-Tsin, first of all, thank you. And your question nailed the answer itself. It’s exactly the dynamic that we are seeing. Very strong long cycle annuity deals with multi-year TCV. Typically, as you know, in our business, that ranges in the order of magnitude of three to slightly above three-year terms on the average, actually closer to four years. And then on the short cycle, you could have three months, six months, nine months, one year, et cetera. And those short-term projects are the ones that have been challenged. And we’ve heard that across the industry. In fact, we’ve heard both dynamics across the industry. What then happens is, we see the 25% at least bookings growth that we talked about, which sets the stage nicely, particularly for digital operations, but also for half of our DataTech-AI, because half of our DataTech-AI is long cycle in nature.

It sets it really nicely for the long haul. The short-term bookings that don’t get done immediately translates to impact on revenue not coming through for the year, and that’s the dynamic we are seeing. Mike, you want to add anything?

Mike Weiner: Yes. What it adds to that is that, if you actually play out what you just said, Tiger, with regard to about 25% projected year-over-year bookings growth and how it manifests itself in the financials for the third quarter, and how we’re thinking about the fourth quarter as well. Our digital operations business grew 6%. We’re expecting it to continue to grow, which the vast majority of the large deals was reflected in there as well as, as you said earlier, about half of the DataTech and AI business is there. So it is a tale of two cities as you kicked off the discussion with incredibly strong transformational large deal wins that make up the vast majority of the pipeline, with some shorter near term non-annuity DataTech and AI pressure that we’re seeing in the third and projected into the fourth quarter.

Tien-Tsin Huang: Great. Thanks for going through that. So just my quick follow-up then, if we’re – so no budget flush, assumed this year makes sense. I heard the comments around 2024 and the acceleration in 2025. But what are you looking for? Is there anything that you can do to maybe catalyze the short cycle work, short of pricing. I imagine changing over the calendar year sometimes helps, but at this stage, it’s probably too early to call. Is there anything that can be done on your side to maybe catalyze that?

Mike Weiner: Yes. The way we’re kind of thinking about it, without getting any specific numbers today with regard to 2024 and how we’re thinking about entering the year. There’s a number of key variables we think about in our business. Obviously, the basis of it with the digital operations business growing strong will act as a fundamental base for us with these large deal signings we had, including the two we had this particular quarter. But really, the variability really comes from our DataTech and AI business that we talked about earlier. Few just points. The pipeline in DataTech and AI remains incredibly strong and growing. So that means there’s huge demand there. The large deals that I mentioned earlier also have a DataTech and AI component into it will continue to ramp up through next year.

But specifically, what could we do and what are we seeing right now? So there’s a huge opportunity associated with generative AI. Specifically, while we didn’t see the budget flushing that we traditionally see in the third and particularly into the fourth quarter, we are not hearing any degradation in terms of generative AI budgets going into next year. So when you think about it, those dollars are what we’re going to go after with our huge focus and investment on data engineering solutions. I think that’s going to be a nice tailwind for us as we go to help us through, particularly in the DataTech and AI to help drive our growth next year above the level that we had this year, certainly.

Tiger Tyagarajan: And just to add finally to what Mike said in terms of some of the specific actions we’ve already taken, we now have a Gen AI set of offerings on the back of the 90 projects and pilots that I talked about, of which 10 are into getting closer and closer to production mode and two are in full production. The more that progresses, the more we get into replication mode. And as you can imagine, Gen AI is a conversation that if you can replicate and start rolling out those solutions, it gets lacked up pretty quickly. So we expect that to be a tailwind. Second, generative AI itself begs the question for our clients as to whether they have all the data lined up. And that’s where Mike’s comment on data engineering is a big one.

We expect data engineering to be one of the tailwinds in our DataTech-AI as we compete this year and enter this year. And those specific actions we are doing in terms of resource allocation into the specific buying centers, industry verticals, and geographies, where we see the most uplift.

Tien-Tsin Huang: Thanks for walking through that.

Tiger Tyagarajan: Thanks, Tien-Tsin.

Operator: Thank you. [Operator Instructions] Our next question comes from David Koning of Baird. David, your line is open. Please check, you’re mute. Please rejoin using the call me feature. [Operator Instructions] Our next question comes from Maggie Nolan of William Blair.

Maggie Nolan: Thank you. I’m hoping you could comment a little bit, it’s great to have you regularly provide kind of that non-FTE percentage that you’ve been giving. Can you give a little bit of color on the traction of that non-FTE work within your high priority accounts and how widespread that is being adopted within those particular accounts?

Tiger Tyagarajan: So, Maggie, actually, it’s a great question. At the total revenue level, our non-FTE commercial models, the penetration is 16%, as you heard in my remarks. And as you remember, we had said that over the long-term 2026 horizon, we’d like to get that to at least 20%. And last quarter I had reiterated that there is a very high probability that we’ll get there faster, because our bookings seems to be tracking, in terms of its penetration of alternate commercial models, higher than that 16%, which is great. And therefore it’ll keep accreting. Within priority accounts, though, that penetration of non-FTE pricing models is higher than the company average. The exact number I wouldn’t be able to give right away, but it’s tracking higher than the company average.