Genpact LTD quarterly report, Q2 FY2020

Genpact Limited 10-Q Summary

Business context and reporting period

Genpact is a global professional services firm providing digitally enabled business process management, analytics, consulting, digital solutions and information technology services. It had more than 96,500 employees in over 30 countries. This unaudited Form 10-Q covers the three and six months ended June 30, 2020, compared with the corresponding 2019 periods.

The quarter was materially affected by the COVID-19 pandemic, including delays in client approvals for work-from-home delivery, postponed or cancelled projects, operational disruptions and lower utilization in certain service lines. The BCMI segment was most affected.

Financial performance and key metrics

Metric	Q2 2020	Q2 2019	H1 2020	H1 2019
Net revenues	$900.1 million	$881.8 million	$1,823.3 million	$1,691.0 million
Revenue growth	2.1%	—	7.8%	—
Gross profit	$306.2 million	$310.6 million	$624.6 million	$600.6 million
Gross margin	34.0%	35.2%	34.3%	35.5%
Income from operations	$90.4 million	$106.2 million	$201.0 million	$196.3 million
Operating margin	10.0%	12.0%	11.0%	11.6%
Net income	$62.2 million	$73.7 million	$147.9 million	$134.6 million
Net margin	6.9%	8.4%	8.1%	8.0%
Diluted EPS	$0.32	$0.38	$0.76	$0.69
Adjusted income from operations	$145.5 million	$136.0 million	$281.2 million	$257.6 million
Adjusted operating margin	16.2%	15.4%	15.4%	15.2%

Global Client revenue increased 2.6% in Q2 and 8.3% in the first half, while GE revenue declined 1.6% in Q2 but increased 4.7% in the first half. GE represented 13% of revenue in both comparable periods and 18% of accounts receivable at June 30, 2020.

Q2 segment revenue was $253.2 million for BCMI, down 8.4%; $306.7 million for CGRLH, up 12.3%; and $352.7 million for HMS, up 5.3%. First-half segment revenue increased 1.2% for BCMI, 15.5% for CGRLH and 8.7% for HMS.

Cash flow, liquidity and debt

Net cash provided by operating activities was $173.1 million in the first half of 2020, compared with $121.0 million in the first half of 2019.
Cash used in investing activities was $39.2 million, including $33.1 million of capital expenditures and $6.4 million for internally generated intangible assets.
Financing activities provided $304.2 million, principally due to $425.0 million of net short-term borrowings.
Cash and cash equivalents increased to $867.4 million at June 30, 2020 from $467.1 million at December 31, 2019. Approximately $866.9 million was held by foreign subsidiaries.
Short-term borrowings increased to $495.0 million from $70.0 million. The company had drawn substantially all of its $500.0 million revolving facility, including non-funded drawdowns.
Long-term debt was $1.357 billion, consisting primarily of a $610.6 million term loan, $349.1 million of 2017 Senior Notes and $397.4 million of 2019 Senior Notes. The principal maturities include the 2017 notes in 2022, the term loan principally in 2023 and the 2019 notes in 2024.
The company remained in compliance with its debt covenants, including a net debt-to-EBITDA ratio below 3x and an interest coverage ratio above 3x.
Total contractual obligations were $2.701 billion at June 30, 2020, including $1.471 billion of long-term debt obligations, $496.5 million of short-term borrowings and $516.1 million of operating lease obligations.

Material changes versus the prior comparable period

Q2 revenue grew modestly, but gross margin declined 120 basis points and operating margin declined 200 basis points because of lower utilization, delayed work-from-home approvals and restructuring-related charges.
Q2 GAAP net income declined 15.7% and diluted EPS declined from $0.38 to $0.32. First-half net income increased 9.9% and diluted EPS increased from $0.69 to $0.76, partly reflecting first-half foreign exchange gains.
SG&A declined 5.1% in Q2 and 1.0% in the first half, reflecting lower travel, marketing and discretionary spending.
Adjusted operating income increased despite the pandemic, supported by cost containment, lower discretionary spending and workforce reductions. This non-GAAP measure excludes, among other items, stock compensation, acquired-intangible amortization and restructuring costs.
The company recorded a $21.7 million COVID-19-related restructuring charge in Q2, comprising $11.2 million of primarily non-cash charges for abandoned offices and related assets and $10.5 million of employee severance. An additional third-quarter severance charge was possible but was not expected to be material.
The company adopted ASC 326, the current expected credit loss standard, on January 1, 2020. The adoption reduced opening retained earnings by $4.0 million, net of tax.
The company acquired Rightpoint in November 2019 for total consideration of $270.7 million, including $21.5 million of estimated deferred variable earn-out consideration. Rightpoint contributed to transformation-services growth, particularly in HMS and CGRLH.
The company paid $37.1 million of dividends in the first half and repurchased 1.0 million shares for $45.0 million. The quarterly dividend was increased 15% to $0.0975 per share.

Outlook, commentary, risks and unusual items

Management did not provide a clear quantitative revenue or earnings outlook in the filing. It stated that pandemic-related effects on demand, profitability and cash flow could continue, and that the ultimate impact of COVID-19 remained highly uncertain. Management expected to reevaluate investment plans, hiring, capital expenditures, real estate usage and discretionary spending. It also indicated that, given strengthened liquidity and improved debt-market conditions, it was likely to substantially reduce revolving borrowings in the second half of 2020.

Key operating risks include prolonged COVID-19 disruption, lower client spending, project delays or cancellations, work-from-home approval constraints, reduced utilization, pricing pressure and higher employee costs.
Customer concentration is material: GE generated 13% of revenue and represented 18% of receivables at June 30, 2020.
Foreign exchange exposure is significant. The company had interest-rate swaps with a $502 million notional amount and substantial foreign-exchange hedging activity.
Tax contingencies in India include demands totaling approximately $146 million, including interest, related to tax years 2009, 2013 and 2015. The company had paid $56 million under protest and had not reserved for the remaining exposure.
The company was appealing denial of a $3.5 million Indian GST refund and could face additional tax exposure if its export-service exemption is ultimately denied.
A judicial interpretation in India could result in additional defined-contribution obligations, but the company stated that the timing and amount could not yet be reliably estimated.
Goodwill was $1.557 billion and intangible assets were $195.6 million at June 30, 2020. The company recorded $10.0 million of impairment charges on intangible assets and property, plant and equipment during the first half.
On July 29, 2020, the board declared a third-quarter dividend of $0.0975 per share, payable September 23, 2020.

Important facts for investors to verify

Whether COVID-19-related demand weakness, client approvals and work-from-home constraints persist beyond the second quarter.
Whether the company reduces the $495.0 million revolving-facility drawdown as indicated and how that affects interest expense and liquidity.
Underlying utilization, pricing, margins and cash conversion after excluding restructuring benefits and other non-GAAP adjustments.
Progress and profitability of the Rightpoint acquisition and the performance of the BCMI segment.
Outcomes of the Indian tax assessments, GST appeal and defined-contribution obligation uncertainty.
Foreign exchange, LIBOR transition and interest-rate-swap effects on earnings, comprehensive income and debt service costs.
The sustainability of the increased dividend and any further share repurchases given pandemic uncertainty and debt obligations.