Genpact Q1 2024 Earnings Call Transcript

Quartr
Provided by Quartr
May 9, 2024

There are 10 speakers on the call.

Operator

Good day, ladies and gentlemen. Welcome to the 2024 First Quarter Genpact Limited Earnings Conference Call. My name is Michelle, and I'll be your conference moderator for today. 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.

Operator

I would now like to turn the call over to Krista Bessinger, Head of Investor Relations at Genpact. Please proceed.

Speaker 1

Thank you, Michelle. Hi, everyone, and welcome to Genpact's Q1 2024 Earnings Conference Call. We hope you've had a chance to read our earnings press release posted on the Investor Relations section of our website, gempac.com. Today, we have with us BK Kalra, President and CEO and Mike Weiner, Chief Financial Officer. BK will start with a high level overview of the quarter, and then Mike will cover our financial performance in greater detail before we take your questions.

Speaker 1

Please note that during today's call, we will make forward looking statements, including statements about our business outlook, strategies and long term goals. These comments are based on our plans, predictions and expectations as of today, which may change over time. Actual results could differ materially due to a number of important risks and uncertainties, including the risk factors in our 10 ks and 10 Q filings with the SEC. Also during this call, we will discuss certain non GAAP financial measures. We have reconciled those to the most directly comparable GAAP financial measures in our earnings press release.

Speaker 1

These non GAAP measures are not intended to be a substitute for our GAAP results. And finally, this call in its entirety is being webcast from our Investor Relations website and an audio replay and a transcript will be available on our website in a few hours. And with that, I'd like to turn it over to BK.

Speaker 2

Thank you, Christa. Hello, everyone, and thank you for joining us today. I'll start with a brief overview of Q1 performance, our updated outlook and then hand the call over to Mike to take you through our financial performance in more detail. Q1 was a solid start to the year with total revenues of $1,130,000,000 up 4% year over year. This was above the high end of our guidance range, driven by early signs of improving execution and better than expected performance across both digital operations and Data Tech AI.

Speaker 2

Gross margin of 35% also exceeded expectations, reflecting operational efficiencies and better than expected revenue performance. Adjusted operating income margin was 16.1 percent in line with guidance reflecting investments in our top priorities. In Q1, as most of you know, we established our 3 +1 execution framework and it is driving promising early results. 3+1 consists of 3 client facing initiatives: partnerships, Datadek AI and simplification and 1 internal facing initiative, Client 0. This is about establishing Genpact as our own best credential for AI led transformation.

Speaker 2

Let me walk you through each one of them. First on partnerships. In Q1, we significantly centered our partnership team and achieved Tier 1 partnership status, the highest level with AWS, Salesforce and Adobe. We have also joined forces with Microsoft. By combining Genpact's leadership in finance and accounting with Azure OpenAI technology, we are transforming finance organizations to best in class, leveraging data and AI solutions.

Speaker 2

2nd, on Datatech AI, we are aggressively driving go to market engagement across data engineering, analytics and AI with specific focus on GenAI. This drove a significant increase in client conversations in Q1 and contributed to better than expected Data Tech AI revenue. We are working with clients to integrate Gen AI into their core business processes. Gen AI is also serving as a driver of foundational work as we help enterprises build the broader data and system architecture that is a prerequisite to succeed in the AI world. Genpact plays a critical role.

Speaker 2

We've bridged the gap between off the shelf solutions delivered by platform providers, bringing domain understanding at a keystroke level. This helps clients install an AI first end to end business process with underlying data and systems in their production environments. Clients choose us for 5 key reasons: 1, deep domain expertise 2, end to end capabilities from strategy and design all the way to delivery and transformation 3, strong partner ecosystem 4, client centricity and 5, full stack data technology and AI stack including our pre built accelerator, the Cora platform. Let me give you a few examples. Nova Data Center, a provider of state of the art data centers is using our AI solution to improve the functionality, integration and operational efficiency of their Boston Dynamics Spot robots Using natural language processing, hardware integration with OpenAI interfaces, these robots have been given features such as AI powered anomaly detection, facial recognition, license plate monitoring and the ability to have human like interaction.

Speaker 2

These features will allow their robots to further enhance security capabilities and monitor critical infrastructure. Or in case of Volkswagen Financial Services, we have integrated GenAI into the production systems. This enables agents to manage servicing requests with significant efficiency. The GenAI translation skills are already launched across 3 countries in Europe and rapidly expanding. This solution has significantly enhanced agents' ability to manage account changes, loan disbursements, addressing customer complaints, while delivering more personalized experience and improved customer satisfaction.

Speaker 2

We are also building responsible AI centers of excellence for clients and this is a significant focus for us. I'll give you a couple examples. Finance organization of a major IT company wanted to automate a range of operational finance activities. We run a portion of their finance and accounting and other operational processes. Taking a page from our own best practices, we established a responsible AI center of excellence for them, bringing functional domain debt, supplementing it with data engineering capabilities and enabling AI deployment.

Speaker 2

It is helping them put various use cases in production at speed. We also established an AI center of excellence for a major life insurance company. For this client, we are building a platform that uses advanced AI techniques that stitches together historical information, product specifications and future projections to enable range of decisions. The first use case will drive the end to end automation of pricing and renewal decisions using AI with human in the loop. These are just few of the examples.

Speaker 2

While it is still very early days, we are seeing increased momentum in GenAI related revenues and bookings and believe we are in a strong position to partner with enterprises to drive competitive advantage moving forward. 3rd, on simplification as part of 3+1. We simplified our sales and go to market leadership structure in Q1, moving from highly matrixed organization to 12 units, which mirrors our client organization. This is strengthening execution and accountability with standardized scorecards, internal management reporting, sales and post sales activity, all supported by a new governance structure that tracks key performance indicator at the unit level. We are now in the process of simplifying a number of additional key elements that will allow us to scale more efficiently.

Speaker 2

And finally, the plus 1 in our 3 plus 1 execution framework is client 0. This is the work we are doing to establish Genpact as our own best credential for AI led transformation. We have identified and are moving forward with more than 50 internal use cases across IT, finance, HR, legal, sales and marketing to drive growth, improve client employee satisfaction, reduce cost and improve cash flow, all by leveraging the same AI tools we use on behalf of our clients. It's early days here as well, but we are excited by the progress we are making. Now turning to our guidance, Mike will go through the details, but I wanted to cover a few important points upfront.

Speaker 2

As I mentioned earlier, we are seeing early signs of improving execution with better than expected results for quarter 1. As a result, we are increasing our full year revenue guidance by 50 basis points to 2.5% to 3.5% growth on as reported basis, up from 2% to 3% previously. Our outlook does not assume any improvement in the macro buying environment. We are simply flowing through the revenue upside from Q1 of approximately $20,000,000 at midpoint of the range through the full year. We are also increasing our gross margin outlook for the full year by 30 basis points to 35.3%, up from 35% previously, reflecting outperformance in Q1.

Speaker 2

Our AOI margin outlook remains unchanged at 17% for the full year, as we continue to invest in our top priorities, partnerships and GenAI to drive accelerating long term growth. In closing, Q1 was a solid start to the year with revenue and gross margin above the high end of our guidance range, reflecting early signs of improving execution. We are excited by the progress we are making and believe our 3 +1 execution framework will be key ingredient in putting us on path to reach our full potential. With that, let me turn the call over to Mike.

Speaker 3

Thank you, B. K, and good afternoon, everyone. Today, I'll review our Q1 results and then provide you with our thoughts on our Q2 and full year 2024 outlook. Beginning with our Q1 results, while we continue to experience pressure in our discretionary short cycled work, demand for our long term annuity based services continues to be strong. Specifically, our pipeline achieved record levels fueled by strong inflows.

Speaker 3

We booked 3 large deals in the quarter. While this was lower than the number in the Q1 of last year, our overall total bookings level was near the level we booked in the same period last year. We also booked 30 new logos in the quarter with an average TCV of approximately $4,500,000 compared to 17 new logos with an average TCV of approximately $5,600,000 last year. Sole source deals represented approximately 40% of bookings and win rates remain elevated at 62%. Total revenue of $1,130,000,000 was up 4% year over year, both on an as reported and constant currency basis.

Speaker 3

This performance was above our expectation, reflecting early signs of improved execution and better than expected performance across digital operations, data tech and AI and all segments. As noted in our press release, we made an enhancement to our data tech and AI and digital operations revenue breakout for more accurate to more accurately reflect revenue from certain solutions. We have also provided historical comparison results in our press release and in our financial fact sheet, which were posted prior to the call. The results I will provide for Data Tech and AI and Digital Operations below will leverage the prior methodology so that you can accurately compare the results to the guide we provided on our year end call. Data Tech and AI revenue, which represents 44% of total revenue, increased 3% year over year on an as reported in constant currency basis.

Speaker 3

Performance was largely driven by service lines in finance and accounting, supply chain and risk. Digital operations revenue, which represents 56% of total revenue increased 4% year over year on an as reported and 5% on a constant currency basis, primarily reflecting deal ramps related to last year's large booking wins. Outcome and consumption based models expanded to approximately 19% of 1st quarter revenue compared to 13% of total revenue in the Q1 last year. Revenue from priority accounts grew 4% year over year and remained at 63% of global revenue with 43% of 1st quarter bookings from priority accounts. From a segment perspective, financial services increased 3% year over year, primarily driven by ramp of large deals and growth in financial crimes, partially offset by continued pressure around client discretionary tax spend.

Speaker 3

Consumer and healthcare increased 5% year over year due to large deal ramps and growth in supply chain engagements. High-tech and manufacturing increased 4% year over year, primarily driven by ramp of new logos in both digital operations and data tech and AI, moderately offset by a partial descoping of a high-tech priority client noted last year. Adjusted operating income margin 16.1%, down 30 basis points year over year, primarily due to increased investments to support growth. Gross margin for the Q1 was 35%, up 100 basis points year over year, primarily driven by less upfront large deal investments and lower severance costs. As a reminder, severance costs were elevated last year from workforce reductions in our short cycled advisory work.

Speaker 3

SG and A as a percentage of revenue increased 90 basis points year over year to 20.8%. The year over year increase was largely due to higher investments to support growth that I mentioned earlier. Note, we also had lower stock comp expense, which does not impact our adjusted operating income margin. Our effective tax rate was 25.2% compared to 23.4% during the same period last year, primarily driven by lower tax deductions related to stock based compensation and the implementation of Pillar 2 global minimum tax rates. GAAP net income was $117,000,000 up 10% year over year.

Speaker 3

GAAP diluted EPS equivalent of $0.64 up 12% year over year. Adjusted diluted EPS of $0.73 up 7% year over year and outpaced revenue growth for the quarter. The increase was primarily driven by the impact of lower outstanding share count of $0.02 higher adjusted operating income of $0.01 and FX remeasurement gain compared to the same period last year of $0.01 and lower taxes of $0.01 Compared to the Q1 of 2023, we grew the number of relationships with annual revenue greater than $5,000,000 from 175 to 187. Additionally, clients with annual revenue greater than $25,000,000 expanded from 36 to 40 and clients with approximately $100,000,000 of revenue remained at $5,000,000 Turning to cash flow and balance sheet. During the quarter, we utilized $26,000,000 of cash from operations compared to utilizing $34,000,000 during the same period last year.

Speaker 3

Days sales outstanding expanded to 91 days from 83 days in 2023 due to collection delays and higher payment terms in new accounts. The overall credit quality of our portfolio continues to be very strong. Cash and cash equivalents totaled $478,000,000 compared to $584,000,000 at the end of the Q4 of 2023, reflecting the return of $57,000,000 to shareholders and annual incentive compensation payout that occurred in the Q1. At the end of the quarter, our net debt to EBITDA ratio for the prior 4 quarters was 1.1x, in line with our preferred 1x to 2x range. With undrawn debt capacity and our existing cash balances, we have ample flexibility to pursue growth opportunities and execute on our capital allocation strategy.

Speaker 3

During the quarter, we repurchased approximately 865,000 shares at a total cost of 30,000,000 dollars and at a weighted average share price of $34.67 per share. Capital expenditures as a percentage of revenue equated to approximately 1.8% in line with our expectations. We remain committed to returning capital to shareholders through a regular cadence of buybacks and quarterly dividends. We continue to plan to pay out approximately 50% of our operating cash flow to shareholders during the year, including a minimum of 30% of our cash flow from operations for share repurchases. Before I provide an update on our outlook for some quick stats on attrition, our attrition rate for the quarter was 23%, in line with 4th quarter levels and the low end of our historic range.

Speaker 3

Adjusted for involuntary attrition and employees with less than 3 months of service, our attrition was 17% during the quarter. Finally, let me update you on our full year 2024 outlook and our Q2 guidance. Genpact's outlook for full year 2024 is as follows: total revenue in the range of $4,590,000,000 to 4,630,000,000 dollars represents year over year growth of approximately 2.5% to 3.5% as reported, up from the prior guidance of 2% to 3%. This includes digital operations revenue growth of approximately 3.6% year over year and DataTech and AI revenue growth of approximately 2.3% year over year at the midpoint of the range as reported. Compared to the previous midpoint of 3.1% and 1.7% respectively on an updated classification basis.

Speaker 3

Full year gross margin of approximately 35%, full year adjusted income from operation margin of approximately 17% and full year adjusted EPS in the range of $3.01 to $3.04 This represents a year over year growth of 1% to 2% and includes higher adjusted operating income of $0.09 positive impact related to lower share count of $0.06 partially offset by the impact of higher expected tax rate of $0.04 higher interest expense of $0.04 and the negative year over year FX impact of $0.02 due to the $4,000,000 re measurement gain recorded last year. As we've communicated in the past, to the extent we're able to deliver revenue upside over the course of the year, our bias will be to reinvest a portion of that upside back in the business to drive future revenue growth. Our 2024 effective tax rate continues to be in the expected of 24.5% compared to 23.4% reported for full year 2023. The increase reflects the implementation of new Pillar 2 global minimum tax rates as well as lower year over year tax benefits related to stock based compensation. We continue to expect cash flow from operations to be approximately $500,000,000 Capital expenditures as a percentage of revenue continues to be expected to be approximately 1.5% to 2% in 2024, which includes investments related to internal system upgrades.

Speaker 3

Our outlook for the Q2 2024 is as follows: total revenue in the range of $1,143,000,000 to $1,148,000,000 representing a year over year growth of approximately 3.4 percent to 3.8 percent as reported. This includes digital operations revenue growth of approximately 5.4%, year over year and data tech and AI revenue growth of 1.6% year over year at the midpoint of the range as reported. Gross margin is expected to be approximately 34.8%, down 20 basis points sequentially and the alignment of our due to the alignment of our annual compensation refresh of employees in 2Q. Adjusted operating income margin is expected to be 16.5%. With that, let me turn the call back over to Christa.

Speaker 1

Great. Thank you, Mike. We would now like to open the call for questions. Michelle, could you please give the instructions?

Operator

And our first question comes from Puneet Jain with JPMorgan. Your line is open.

Speaker 4

Hi. This is Nina on for Puneet. Congratulations on the results. Of course, it's still early, but now that you guys are kind of seeing some of the benefits of your new strategies such as 3 plus 1 payoff on the P and L, is it too soon to start thinking about longer term revenue targets? I think we're currently modeling you guys at high single digits, but I know the previous target was closer to low double.

Speaker 4

So just would appreciate any color here.

Speaker 3

Yes. So it's Michael. I'll kick this off and I'll turn it over to BK. Right now, we're really focused on our execution in 2024. So at this point now, I think we're comfortable with the ranges we provided for this year.

Speaker 3

And as we get additional clarity as we move forward in the year, we'll provide additional color on a go forward basis.

Speaker 2

Yes. And if I may add, we don't see any change in the macro environment. And in our model, macro environment is more baked in where it was the back half of last year. But we are in tools with our early execution and we'll continue to update as we go along.

Speaker 4

Great. Thank you.

Operator

Thank you. Our next question comes from Bradley Clark with BMO. Your line is open.

Speaker 5

Hi, this is Brad Clark on for Keith Bachman. Thanks for taking my question. I wanted to hone in on the comment on GenAI for your clients. I think you said better than expected revenues and bookings in the quarter. Is there any other color that you can provide to help shape perhaps the size or depth of the business and where you're seeing early traction with clients?

Speaker 2

So, Brian, I'll take 3 comments. 1, obviously, these are early days, not just for us, for our clients or overall in the industry. But in the early days, we see a lot of interest from clients relative to many of the technology waves that we saw in the past. Point number 2, I think we are seeing therefore enhanced conversations and a number of those conversations convert into booking and revenue. And a number of those conversations don't convert.

Speaker 2

They just stay as an excitement and possibilities that we can harness and that we need to kind of handhold our clients as we go along. And last point, I think what we have seen in booking and revenues is still a very, very small portion. So we have set up our systems to see that on a consistent basis. And as it solidifies, as it progresses at some point in time, we will share more light on that.

Speaker 3

Yes. P. K, let me just elaborate on some of those comments, right. While we're not providing any quantitative benefit to the question, I think it's very interesting. Today we sit between the client and the hyperscaler and large enterprise technology companies.

Speaker 3

And the vast majority of all of our client conversations are how can we help in the middle of those two things. And we think that's going to be a real driver for us for future growth.

Speaker 5

Great. Thank you.

Operator

Thank you. Our next question comes from Maggie Nolan with William Blair. Your line is open.

Speaker 4

Hi, thank you. Can you dissect for me in a little bit more detail where the outperformance came from in Q1? Is there anything about that that's one time or non recurring or timing considerations that we should keep in mind as we think about how Q2 might shape up in comparison to Q1?

Speaker 3

No, I think it's from that perspective. It's Mike answering the question. Hey, Maggie, how are you? So in the Q1, right, if you think about our business, our 2 revenue disaggregation units, our digital operations revenue, right, it was with better expected execution, particularly regarding the deal ramps of the large deals that we implemented in the 3rd Q4 of last year. We continue to execute really well on that.

Speaker 3

As far as our Data Tech and AI business versus our expectations, project work, particularly in finance and accounting, supply chain really drove a lot of that outperformance.

Speaker 2

And if I can add, Mike, look, where it is all coming from in early days is all about our 3+1 framework, Maggie. So take an example of partnerships. In partnerships as one of the key attributes in 3+1, We invested in really strong talent, including a leader and a team in there and started engaging with technology partners. And what we see in more detail, the inflows are roughly 2.5x to 3x relative to the corresponding period last year. Or if I go into, like Mike was saying, in Data Tech AI, how our employees are also embracing this pivot, there are more and more conversations happening with the clients on data and AI.

Speaker 2

And some of it you've already seen our results in Datatech AI. So clearly, the investments that we are making, the pivot that we are embracing is showing some early results as well as the cadence of governance and execution that we have put in place.

Speaker 4

Thank you. That's great to hear. When you think about all those changes that you are making within the organization now that some of that is underway, particularly on the sales team? Can you talk a little bit about reception of those changes, culture? Have there been any changes in voluntary attrition within the group?

Speaker 4

Thanks for taking my question.

Speaker 2

Yes. Thanks, Maggie. And what I can tell you is that overall, there is a level of excitement in the team, excitement because everybody is clamoring to deliver better results, point number 1, and they see their efforts pay off, though I think we all are aware that they are a little bit more coming in from easier comps, I would say that. 2, I think with these routines and rituals and there are few routines and rituals that are getting etched for now and in future. Those routines and rituals are yielding results and a number of our colleagues are seeing the results of their hard work pay off.

Speaker 2

So I would see that I would say that a lot of there's a lot of excitement that I can feel in a palpable manner. We also hired north of 50 leaders at our senior level in last 90 days or in Q1 and more focused on data, technology, AI also in partnerships. And all of that support is enabling our existing staff to progress further with clients.

Speaker 4

Thank you.

Operator

Thank you. Our next question comes from Ryan Potter with Citigroup. Your line is open.

Speaker 6

Hey, thanks for taking my question. It was nice to see the solid execution and the return to the sequential growth that's implied in the 2Q outlook you have here. I was wondering if you could comment on the visibility that you have into this 2Q outcome in the remainder of the year. Are you expecting sequential growth for the remainder of the year past 2Q? And what kind of assumptions have you made around things like discretionary spending, which I know sometimes kind of more of an impact on DASK and AI?

Speaker 3

Yes. So this is Mike. Let me kind of kick that off and I'll turn it over to B. K. We're not really looking to provide additional color on really how we're seeing it out greater than this year in 2024.

Speaker 3

But what I'll talk about is really our second half in terms of what our guidance is really based on, particularly with regard to revenue, which I think you're alluding to. It's a prudent guide to be completely frank with you, right. We have not anticipated any real change in the macro environment, particularly from the second half of twenty twenty three and through Q1 of twenty twenty four, right? We have the large deals that we did flowing through. And yes, arguably off of a poorer comp, but that's really what's reflected in our second half revenue ramp.

Speaker 2

Yes. And I think the only add that I have, Ryan, is for the Q2 guide, clearly sitting on May 9, we have better visibility to what will happen in next 55 days. And on the second half, Mike, in any case, responded to that question.

Speaker 6

Got it. And then just quickly on productivity commitments from clients. Can you provide some more color, I guess, on trends you've been seeing there? Like has the macro or increased interest in AI led to clients asking for higher levels of productivity than in the past in your core services?

Speaker 2

So there is a lot of interest from clients on AI, but there has not been any increase in productivity expectations that we see in our all of our client conversations and renewals, in new signings. And reality is, Ryan, that we always baked in a lot of productivity based on AI tools. Now, yet then AI is new. What we see is interest from clients to learn more about the how. That certainly has changed, but not the quantitative side of hows.

Speaker 3

Yes. We've also seen, we talked about in our prepared remarks, a nice amount of growth in our turn of commercial models, right, moving away from FTE related pricing, which all supports the implementation of a lot of this new technology.

Speaker 6

Got it. Thanks.

Operator

Thank you. Our next question

Speaker 7

I wanted to ask a follow-up question on the go to market changes that Maggie had asked. Specifically, are the changes to your sales and go to market organizations, are those fully implemented as you exited the Q1? Or do you have incremental kind of changes that you're now pursuing in 2Q and as you go to the balance of this year?

Speaker 2

Thanks, Brian. So look, I think we have made a number of changes and we'll continue to evolve as we progress through the year, as 3 plus 1 takes hold as well as as client as we continue to engage with clients and learn more on their needs. So it's a continuous evolution and there's nothing new. I think what we did was a surge of changes that we have driven. But fundamentally and as an example in simplification, we moved from a matrix organization to finite 12 unit that truly faced declines and brought in a lot of decision making to those 12 units.

Speaker 2

And those changes happened in Q1. But there are as we continue to progress, I think we will continue to improve it on the edges as well as bringing in new talent that pushes the agenda of data and technology and AI further.

Speaker 3

Yes. And thus far, the execution has been wonderful. We had a nice growth in terms of our inflows and our bookings, but more to come.

Speaker 7

Okay. Very good on that. And then just pivoting to gross margin here. So just first a clarification on the 1Q. I thought I heard you say you had less large deal upfront investments.

Speaker 7

So if I'm right on that, what does that do to? And then can you just talk about the drivers as you go through the balance of this year, the cadence of gross margin, understand you took the outlook for gross margin up a bit here for the year, but the 2Q downticks, I think, first before you build in a second half recovery. So just help us with the moving parts as you go through the year for gross margin?

Speaker 3

Sure. So our gross margin, I believe in the Q1 was up about 100 basis points, right? And I think what you're referring to is prior year comps with lower severance and less large deal investments than we had in the prior year as well as lower stock expense that really drove that increase. And as far as we have increased our gross margin as we continue to move through the year, we're flowing through the revenue that we had in terms of better than expected revenue in the Q1. And we have enhanced operating leverage, which were flowing through in terms of the gross margin for the remaining part of the year in our guide.

Speaker 7

All right. Thank you.

Operator

Thank you. Our next question comes from Bryan Keane with Deutsche Bank. Your line is open.

Speaker 7

Hey guys, congrats on this solid execution here. I guess my question BK, 62% win rates that seems elevated to me. What would you point to? Is it the pitch or go to market strategy that's pushing up the win rates?

Speaker 2

Yes. If you thanks, Brian. If you look at even last year where we ended, when this were in the range of 60%, and I completely agree with you that they are really high win rates. And what is driven by is 2 factors. 1, there is a lot of small deals and medium sized deals where we do a lot of sole source and that is helping us improve our win rates.

Speaker 2

And do even there are as we have onboarded many clients, there are follow on larger deals that we are doing. And some of these follow on deals that we do, they happen to be sole source and therefore our win rates improve because they have already seen the CA2 ratio, they have already seen the performance that we drive in the account. Having said that, I would say that, yes, they are very high win rates, and I'd rather have a bigger pipe. And we have a record level of pipeline as I speak today. But it won't hurt to increase the pipeline further, and that's where our effort is.

Speaker 2

And even if some of the wind risk goes down, I'll be less bothered by that.

Speaker 7

Got it. And then my follow-up is just looking you've increased gross margin, but not operating margin or adjusted operating margin. Maybe what is the cause of that? And in Q2, the margin guide is 16.5% is a little lower than we had in our model. So just thinking about the puts and takes there as well.

Speaker 7

Thanks.

Speaker 3

Yes. So let me first address your first question really with regard to yes, I think what you're asking is our gross margin up and we're holding our AOI relatively constant from our initial guide, right? So in our prepared remarks, to the extent we continue to execute on better revenue performance, what we're going to do is essentially focus that on increasing our investments, our timed investments in our business. So if you kind of think about the model on a go forward basis that's really driving this, better revenue that we flowed through in the Q1, We'll have the operating leverage on growth that we have on a go forward basis. And as client 0 for the company, we continue to execute on our own efficiencies.

Speaker 3

What we're going to do with all three of those positive is we're going to deploy those back in the business and focus really on generative AI investments.

Speaker 7

And then just the second quarter in particular?

Speaker 8

Sure. I'm

Speaker 3

sorry. It's relatively the same thing for the Q2. In terms of I think your question is, while it why it's 16.5%, right? I think it's really I can't really comment on your model, but it really results in if you look at our seasonal pattern, it's pretty much in line.

Speaker 7

Got it. Thanks for the color.

Speaker 2

Thank you, Brian.

Operator

Thank you. Our next question comes from Moshe Katri with Wedbush. Your line is open.

Speaker 9

Thanks. Congrats on strong execution. I have a couple. First, as the model continues to shift towards outcome based pricing or what you call, I guess, non SDE based pricing, how should we think about the model at Genpact changing in terms of profitability, headcount, etcetera? And then the follow-up is more about discretionary work.

Speaker 9

Which part of the revenue base considered discretionary at Gen 5? Thanks a lot.

Speaker 3

So let me kick it off and I'll hand it over to BK, right. So what we've seen thus far in terms of our alternative commercial or non FTE related pricing, we've actually seen the contrary in terms of the average margin on that work that we do is higher than the average of the company as a whole, right. Yes, and we continue to believe that there'll be an enhanced decoupling between revenue and FTE related costs.

Speaker 2

Yes. Exactly to the point that you're making, Mike. We are increasingly seeing that decoupling and we are pushing that decoupling of FTE to revenue. And I would again say we are in the early stages of that and we are putting certain architecture infrastructure in place to over a period of time build more momentum there. And clearly, more of our investments are also going, Moshe, in building IP and building repeatable assets that we can deploy over and above, say, software of our partners.

Speaker 2

And we are again at early stages of that as more and more data and IP takes hold, more disassociation of revenue with FTE will happen and that's where our endeavor is.

Speaker 7

And the best question I speak for the business?

Speaker 2

Say that again, your voice broke up here, Moshe.

Speaker 9

How about the discretionary part of the question in general?

Speaker 2

Or discretionary part. So I think and the question on discretionary is that what portion of our business is associated with discretionary? Just wanting to clarify because your voice is a little bit muffled.

Speaker 7

That's correct. Yes, that's correct.

Speaker 2

So we have in Datatech AI, Moshe, what we have is also a lot of consulting and portions of projects that we do, over 70% of our revenues is annuity. And so bulk of digital ops and a large portion and a significant portion even in Data Tech AI is annuity for us. They are long term contracts. But as we think of the end to end capabilities, one of the reasons why clients buy from us is strategy design to run and transform. That strategy and design portion of it has componentry, which is tied to discretionary.

Speaker 2

And owing to better execution, our pipeline is looking better, but we don't see it is because budgets have been released. It is more because we are becoming more agile in the marketplace, if that answers the question. Thanks.

Operator

Thank you. Our next question comes from Surinder Thind with Jefferies. Your line is open.

Speaker 8

Thank you. Just to follow-up on the non FTE revenues and the mix shift over the past year. How should we think about that on a go forward basis? Because the shift is pretty significant in the past year. So were there a few projects, a few clients that drove that?

Speaker 8

And is this something that's going to be maybe lumpy go forward? Or where do you kind of see the end game for this?

Speaker 2

So I'll take that and Mike will be to add. Look, Surinder, our endeavor is to push that agenda more, be it in large deals, and we have succeeded in few large deals, or in renewals, or in smaller and medium sized deals. And even if the entire large deal or a medium sized deal is not on non FTE. I think there are portions of it that we are inserting is point number 1. Point number 2, I already spoke about IP and data and these are early days.

Speaker 2

So clearly, our where is the end game? It is too early to tell. What we are exceptionally clear that we want to break this association of Feet with revenues and have revenue growth disproportionately relative to the Feet headcount. And I think we are putting architectural and infrastructural elements around that, and we'll continue to report progress. Mike?

Speaker 3

Yes. I'm just going to build on that, right. So historically, historically over the last 2 years, I would say, we disproportionately saw on renewals our ability to get these models implemented. But I think one of the interesting thing regarding our generative AI conversations we're having with clients initially, they're much more receptible to moving to those models than they were historically. So the generative AI narrative, right, is acting as a catalyst for those discussions as well as just our pivot to have more IP related assets that have to drive that decoupling.

Speaker 8

That's helpful. And then when I think about just guidance in general, I look back to last year and obviously the environment has been challenging. It's been hard to predict client behavior. Fast forward to this year, you guys are out executing the guide. How should I think about the overall quality of the guide or any methodology changes that you guys have made?

Speaker 8

Is it just you guys are being maybe a bit more conservative this year? Any color there would be helpful or how you've been adapting to maybe the lower levels of visibility in this environment?

Speaker 3

Yes. So nothing has changed from what we told you about a quarter or so ago with in terms of our methodology on a go forward basis. Obviously, we get smarter every quarter that we go. Listen, I will say it's prudent from that perspective and that prudency really relates to our assessment that the macro environment, particularly that affects some of our more discretionary shorter duration work has not improved, right, in our models from the second half of last year through the Q1 of this year. To the extent that changes, yes, potentially we could see additional benefits to it.

Speaker 3

But for now, I think the prudent way to move forward is using the information that we have best of our ability and making a conservative view from that perspective. Keep in mind, as BK alluded to, over 70% of our business is somewhat annuitized and we have very good visibility at any given point on how that's going to perform for the remaining piece of the year on a rolling 12 month basis. So it really comes down to that 25% roughly cohort of our business at short term discretionary in nature. And again, what we're doing is we're tying that to our assertion of where the macro business environment is going to be for that period of time. As it changes, we'll update our guidance accordingly.

Speaker 6

Thank you.

Operator

Thank you. Our next question comes from Sean Kennedy with Mizuho. Your line is open.

Speaker 7

Hi, everyone. Nice job on the quarter and thank you for taking my questions. Can you touch on how the demand environment for new business progressed throughout the quarter, both for the shorter duration discretionary deals and the larger ones as well? It seems like the outperformance in the quarter was more GenFacts specific execution versus the macroeconomic environment. Thank you.

Speaker 2

So Sean, what I would say, yes, I think the execution and early signs are good. However, I'll also say that our pipeline is at our record level across all the segments across Data Tech AI and across digital ops. And now we can also attribute a lot of that to our increased agility, again, acting more proactively with our partnership and with technology partners. And we are getting more and more invites from our technology earlier that with understanding of hands on the keyboard and the assets in strategy and design and how we run and transform, we are able to capture the knowledge at a very keystroke level, which a lot of technology partners coming top down are not able to. And that is the true execution that is needed by clients.

Speaker 2

And therefore, there's a reaffirmation and we are seeing as we engage more actively with clients to reflect that in our pipelines. Now I would again continue to maintain with there are many ways in which we see where the macro environment is, where the budgets are. Have we seen any significant or any meaningful improvement there? The answer is no. It continues to be as it was at second half of last year.

Speaker 2

So that is what is sitting in our prudent guide.

Speaker 7

Great. Thank you. Good luck with the rest of the year.

Operator

Thank you. I'm showing no further questions at this time. I'd like to turn the call back over to the company for closing remarks.

Speaker 2

Well, thank you so much, Michelle. And what would say is Q1 was a solid start to the year with revenues and gross margin above high end of our guidance range. Early signs of improving execution and we are excited with that progress we are making with our 3 plus 1 execution framework. And yes, we are pleased with the beat and flow, I would say, with the student guide. And I do want to take this opportunity to thank all of our employees for embracing the pivot, all of our clients for choosing Genpact and all the shareholders for ongoing support.

Speaker 2

And I do want to thank you all and we'll come back to you next quarter.

Operator

Thank you for your participation. This does conclude the program. You may now disconnect. Good day.

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Earnings Conference Call
Genpact Q1 2024
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