Earnings Call Transcript - G Q1 2020

Operator, Operator

Good day, ladies and gentlemen. Welcome to the 2020 First Quarter Genpact Limited Earnings Conference Call. My name is Bridgette, and I’ll 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 towards the end of this conference call. As a reminder, this conference 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, Head of Investor Relations

Thank you, Bridgette, and good afternoon, everybody, and welcome to Genpact’s first quarter earnings call to discuss our results for the quarter ended March 31, 2020. We hope you had a chance to review our earnings release, which was posted to the IR section of our website. The speakers on our call today are Tiger Tyagarajan, our President and CEO, who is joining from his home in New York City; and Ed Fitzpatrick, our Chief Financial Officer, joining from his home in Pennsylvania. We’ve a lot to cover during today’s call, including Genpact’s response to the COVID-19 crisis, our positioning for a path to longer-term growth, a review of our financial performance. We will also provide some color related to our expectations for our second quarter results. Our prepared remarks will be somewhat longer than usual, but we will provide extra time to answer all of your questions. As a reminder, some of the matters we will discuss in today’s call are forward-looking. These forward-looking statements 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. Additionally, during our call today, we will refer to certain non-GAAP financial measures that we believe provide additional information to enhance the understanding of the way management views the operating performance of our business. You can find a 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, President and CEO

Thank you, Roger. Good afternoon, everyone, and thank you for joining us today for our 2020 first quarter earnings call. I’m extremely proud of the passion and dedication of the Genpact team around the globe who have worked tirelessly to support our clients, deliver phenomenal service, and help communities, especially in these unprecedented times. The COVID-19 crisis has disrupted personal lives, businesses, and economies around the world in a very short period. Today, I will start with a quick review of our first quarter results and then share an update on our response so far to COVID-19. I will then discuss the status of our delivery to clients, learnings from our journey to work-from-home, and the impact we are seeing on our clients and their industries. I will also cover the new opportunities we are seeing in the market, why we are well-positioned to win these opportunities, and how our strategic focus over many years, particularly over the last five, allows us to be resilient in these times and sets a clear path forward for longer-term growth in the post-COVID-19 world. Despite the challenges faced starting in the second half of March, we had strong first quarter results, demonstrating a continuation of the momentum seen throughout 2019. All of our industry verticals—consumer goods, retail, life sciences, healthcare, banking and capital markets, insurance, high-tech, and industrial manufacturing and services—grew nicely. Transformation Services was once again the leading engine with particular strength in analytics and significant new traction in our cloud services. Specifically, total revenue was $923 million, up 14% on a constant currency basis, and Global Clients revenue increased 15% on a constant currency basis. We also delivered an adjusted operating income margin of 14.7%, with adjusted diluted EPS of $0.53, up 23% year-over-year. Transformation Services, including the contribution from Rightpoint, grew more than 30% in the quarter, accounting for approximately 30% of total Global Clients revenue. We were off to a strong start in the year, continuing to see traction in our underpenetrated target markets. We saw early signals of the COVID-19 crisis in our China operations, where we have more than 4,000 associates serving several of our Global Clients in China, Japan, South Korea, and the Northern Asian economies, responding with an agile switch to work-from-home. As COVID-19 began to spread throughout the world in the second half of March, we reacted quickly across our global footprint, including Europe, US, Latin America, the Philippines, and India, with our China playbook as a great starting point. We estimate a loss of about $7 million in first quarter revenue, primarily driven by supply constraints during the transition to work-from-home. Much of the revenue loss on the supply side was related to delays in approving work-from-home by many of our banking and capital market clients due to regulatory constraints and privacy and security concerns. From the very beginning of the crisis, our decision-making framework has been focused on two key pillars: 1) ensuring the safety, health, and well-being of our 95,000-plus global team members; and 2) continuing to deliver services to our clients, knowing that the work we do for them is essential to make their businesses and economies function effectively. On day one, we established a global COVID-19 response task force with eight specific work streams to ensure rapid decision-making. Overall, I’m proud to report that more than 95% of our revenue coverage is being delivered. The single biggest gap in reaching 100% virtual is in our banking and capital markets vertical, where client approvals to work-from-home in processes that manage highly sensitive customer information have taken time and varied by regulatory jurisdiction. To protect the long-term health of our business and continue investing strategically in areas that will fuel growth in the future, we have taken decisive action to reduce our cost base, such as a freeze on all salaries across the organization, including our executive leaders, and a hold on internal promotions for the year after paying out 2019 bonuses in full. We also have a temporary ban on all team member travel globally to ensure the safety of employees and clients, as well as a pullback on all discretionary spending. Our proprietary platform TalentMatch has been instrumental in identifying talent available for redeployment as client needs change. This, combined with our Genome reskilling platform, has been a significant success during these times. The strength of the portfolio choices we made as part of our 2013 strategy has made a huge difference, both in terms of industry verticals and service lines. Our global delivery footprint, balancing onshore, nearshore, and offshore delivery, has been a major driver of resilience. We have rapidly adopted virtual collaboration tools to efficiently deliver our services. Many core enterprise services, including finance and accounting, sourcing and procurement, and supply chain are non-discretionary. We estimate that more than 85% of our portfolio is well-positioned to weather the current short-term economic challenges. We see heightened demand for solutions in supply chain management, consumer banking collections, and analytical services to various industries. The COVID-19 pandemic has reinforced the importance of executing flawlessly, maintaining client intimacy, and achieving high Net Promoter Scores as the guiding principles of our culture. The majority of our revenue comes from clients whose relationships have strengthened throughout this crisis, creating a strong stage for growth as they emerge from it. As we're experiencing a slowdown in our large deal pipeline, activity in other segments continues to be present, albeit at a slower pace. The pandemic has also generated new large-scale multi-function transformation deals—just in the last three weeks, we were awarded a new relationship with a global insurance client and are ramping up with an existing large global banking client. We are solutioning and smoothly transitioning over 2,000 people remotely for over 40 clients. Transformation Services engagements have continued demonstrating both our ability to deliver virtually and the essential nature of some updated programs. The last couple of months have underscored the need for flawless execution, client relationships, and user experience as our guiding compass. Our exposure to industries hit hardest by the pandemic is limited, and our long-term financial goals remain intact. Thank you for your continuous support, and I will now turn it over to Ed.

Ed Fitzpatrick, Chief Financial Officer

Thank you, Tiger, and good afternoon, everyone. Total revenue for the first quarter was $923 million, up 14% year-over-year both as reported and on a constant currency basis. We saw broad momentum in our business and revenues exceeded expectations despite late headwinds driven by COVID-19. The impact from the onset of COVID only affected the last few weeks of the first quarter, resulting in an estimated loss of approximately $7 million of revenue. Global Client revenue, which represented 87% of total revenue, increased 14% year-over-year or 15% on a constant currency basis, largely driven by growth across our portfolio. Transformation Services continued to lead the way with strong contributions from analytics and digital solutions. We grew the number of Global Client relationships with annual revenues over $15 million to 52, and those with more than $50 million growing to 10 from 8. Adjusted operating income margin was 14.7%, compared to 15% during the same period last year. Gross margin for the first quarter was 34.5%, which included the impact of COVID-related costs. Adjusted EPS was $0.53, up 23% year-over-year. Due to COVID-19, we've temporarily suspended share repurchases. Our cash and cash equivalents totaled $402 million, compared to $325 million at the end of the first quarter of 2019. We estimate the incremental interest expense related to recent cash drawdowns is approximately $2 million for the quarter. Accounting for all variables, we anticipate second quarter revenue to be down 3% to 5% year-over-year on a constant currency basis. We will continue to assess the business environment and will adjust our cost profile to ensure we balance current financial results with long-term growth initiatives. Looking ahead, we believe second quarter revenue will be the lowest for the year as we expect recovery in both May and June based on increasing client approvals for work-from-home arrangements. Our total addressable market remains attractive and growing, with our pipeline at record levels. I will now turn the call back over to Tiger.

Tiger Tyagarajan, President and CEO

Thank you, Ed. As we look beyond these unprecedented times, we expect permanent changes in the way the world operates. Businesses will need to find new ways to lead, build resilience, connect across ecosystems, and adapt to a changing workforce environment. Our culture of embracing change and focus on client outcomes will be key differentiators. There are five trends we believe will shape the future of business: a significant shift from offline to online, virtualization of technology and services, accelerated consumption of cloud-based services, exponential growth in real-time predictive analytics, and a focus on human-centered design. With the ability to access talent beyond geographical constraints, we can find the right people for the right clients and processes. I want to once again recognize the amazing work of our teams that have come together during these difficult times. Our values have guided our 95,000-plus team members around the shared purpose of helping our clients. We are proud of our role in keeping the global economy running. We have engaged with communities, providing food and hygiene products in various countries, donating masks, supporting non-profit organizations, and enabling education for children during lockdowns. By working together with our clients and communities, we believe we will emerge from this crisis as a stronger company ready to navigate the post-COVID-19 world. I will now turn the call back over to Roger.

Roger Sachs, Head of Investor Relations

Thank you, Tiger. We’d now like to open our call for your questions. Bridgette, would you please provide the instructions?

Operator, Operator

Our first question comes from Ashwin Shirvaikar with Citi. Your line is open.

Ashwin Shirvaikar, Analyst

Thank you. Hi, Tiger. Hi, Ed. Appreciate the commentary, and hope you guys are doing well. I want to start with a comparison of your 1Q performance plus the $7 million you mentioned for efficiency-type losses related to the lockdown. It’s a modest sequential decline from 4Q, which is good relative to even a normal sequential pattern, let alone one affected by a pandemic. What’s driving this? Are there one-off projects in here? I want to make sure there aren’t onetime revenues or pull-forwards of some kind, and could you also talk about the inorganic contribution?

Tiger Tyagarajan, President and CEO

Yeah. So, I’ll start off, Ashwin, by saying that we did have a really good first quarter. Every one of our verticals delivered. Transformation Services delivered, including Rightpoint. So, we did have a really strong start to the year in the first quarter, but as I mentioned, COVID-19 impacted the last two weeks. There are no one-timers in our results. Ed?

Ed Fitzpatrick, Chief Financial Officer

Yeah. It was noteworthy that every sub-vertical saw nice growth. This was one of the most pervasive growth quarters we’ve had. We thought it would be good, and it was even better than expected, but impacted by the headwinds we saw towards the latter part of March.

Ashwin Shirvaikar, Analyst

Got it. So, you had a strong start. Regarding the revenue trend from 1Q to 2Q, could you help size the cost actions you are taking? Are they in that $15 million to $17 million per quarter range benefit for normalized margins? Any sizing, timing impact, cash versus non-cash would be helpful.

Ed Fitzpatrick, Chief Financial Officer

Tiger, let me start. Q2 is going to be a meaningful drop. We are taking appropriate actions regarding utilization levels. A chunk of our losses is due to the approval to work from home. Once clients approve, we expect significant improvements in margins. However, we’re committed to ensuring our organization size aligns with long-term growth as we plan for recovery.

Tiger Tyagarajan, President and CEO

Exactly. It’s vital to achieve a balance between short-term financial performance and building strengths in the changing business landscape. I’m optimistic about the value we can deliver to our clients in this evolving environment.

Ashwin Shirvaikar, Analyst

By the way, I should have mentioned in the beginning, I appreciate the good work you guys are doing in your community.

David Koning, Analyst

Yeah. Hey, guys. Impressive quarter. Good to catch up with you. I guess, on Ashwin’s question too, the sequential decline implies around $75 million to $90 million. How much of that is just the $7 million loss impacting certain banking clients? Is it about half of the decline?

Tiger Tyagarajan, President and CEO

I would say approximately 40% can be classified as supply-driven, and the rest as demand-driven. The $7 million loss in the first quarter was entirely supply-driven, while about 60% reflects a slowdown in decision-making on large deals due to the pandemic’s impact.

Ed Fitzpatrick, Chief Financial Officer

For the first quarter, Rightpoint contributed in line with our full-year expectations. Like we previously indicated, it should account for approximately 2.5% of total revenue.

Tiger Tyagarajan, President and CEO

Rightpoint had a solid first quarter, and I anticipate continued growth in the post-COVID-19 world due to the relevance of their services in this new economy.