Genpact Limited 2018 Q2 Form 10-Q Summary
Business context and reporting period
Genpact is a global professional services company providing digitally led transformation, business process outsourcing and information technology services. It had more than 80,000 employees serving clients in more than 20 countries. This unaudited Form 10-Q covers the three and six months ended June 30, 2018, with comparisons to the same periods in 2017.
Key financial metrics
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net revenue | $728.6 million | $670.7 million | $1,417.5 million | $1,293.7 million |
| Gross profit | $265.7 million | $256.2 million | $510.3 million | $495.8 million |
| Gross margin | 36.5% | 38.2% | 36.0% | 38.3% |
| Operating income | $79.5 million | $81.0 million | $143.3 million | $160.1 million |
| Operating margin | 10.9% | 12.1% | 10.1% | 12.4% |
| Net income attributable to shareholders | $64.6 million | $68.9 million | $129.3 million | $122.3 million |
| Diluted EPS | $0.33 | $0.36 | $0.66 | $0.62 |
| Operating cash flow | Not separately provided for the quarter | Not separately provided for the quarter | $49.5 million | $115.3 million |
Q2 revenue increased 8.6% year over year, while management reported approximately 8% constant-currency growth. Global Client revenue increased 9.2% to $663.1 million and represented 91.0% of Q2 revenue. GE revenue increased 3.6% to $65.4 million in Q2, but declined 6.8% year to date to $123.5 million.
BPO revenue increased 8.9% in Q2 and 10.5% year to date. IT services revenue increased 7.1% in Q2 and 5.0% year to date. Average headcount increased 4.3% in Q2 to approximately 78,400 and 3.3% year to date to approximately 77,700.
Liquidity, debt and capital allocation
- Cash and cash equivalents declined from $504.5 million at December 31, 2017 to $333.9 million at June 30, 2018.
- June 30 debt comprised $215.0 million of short-term borrowings, $39.2 million of current long-term debt and $987.3 million of long-term debt. Total reported debt was approximately $1.24 billion, implying approximate net debt of $907.7 million before other adjustments.
- Operating cash flow was $49.5 million for the first half, versus $115.3 million in the prior-year period. Investing cash use was $54.4 million, and financing cash use was $141.3 million.
- Cash uses included $130.1 million for share repurchases, $28.6 million for dividends and $20.0 million for long-term debt repayment.
- The quarterly dividend was increased 25% to $0.075 per share, or a planned annual rate of $0.30 per share.
- The company remained in compliance with applicable debt covenants at June 30, 2018. Cash held by foreign subsidiaries was $332.5 million of total cash, with $241.2 million described as indefinitely reinvested.
Material changes versus the prior comparable period
- Revenue growth was solid, led by Global Clients and BPO services, but profitability weakened as cost of revenue grew faster than revenue.
- Q2 gross margin declined 170 basis points and year-to-date gross margin declined 230 basis points. Management cited wage inflation, higher operational and onshore headcount, acquisitions, unfavorable foreign exchange and lower personnel utilization.
- Q2 operating income declined 1.8%, and operating margin fell 120 basis points. Year-to-date operating income declined 10.5% and operating margin fell 230 basis points.
- Q2 net income attributable to shareholders declined 6.3%, while year-to-date net income increased 5.7%. The year-to-date benefit included higher other income, principally Indian export subsidies, and favorable foreign exchange results.
- Net interest expense increased to $18.5 million year to date from $15.3 million, reflecting higher LIBOR, senior-note interest and higher revolving-credit usage.
- Shareholders’ equity declined 9.0% to $1.30 billion, primarily reflecting share repurchases, dividends and a $128.7 million other comprehensive loss driven by currency translation and cash-flow hedge losses.
Accounting, outlook, risks and unusual items
- Genpact adopted ASC 606 on January 1, 2018 using the modified retrospective method. Opening retained earnings increased by $17.9 million, and contract cost assets were $162.2 million at June 30. Reported revenue was unchanged by adoption for the periods presented, but Q2 and year-to-date 2018 SG&A and net income were higher than they would have been without the new standard by $1.5 million and $1.2 million after tax, respectively.
- The company recorded an $850,000 impairment charge for computer software and a technology-related intangible asset after termination of related customer contracts.
- Other income included $25.7 million of government incentives in the first half, primarily an Indian export subsidy that management said was available through March 31, 2019. The filing provides no formal full-year revenue or earnings guidance.
- On July 16, 2018, Genpact agreed to acquire Barkawi, a supply chain management consulting business, for estimated cash consideration of $100.1 million, subject to customary closing conditions.
- On August 9, 2018, after quarter-end, Genpact refinanced $910 million of existing borrowings with a five-year $680 million term loan and $500 million revolving facility. The stated borrowing rate was LIBOR plus 1.375%, subject to rating adjustments.
- Key risks include client retention and concentration, GE relationship exposure, wage inflation and employee attrition, foreign-exchange volatility, LIBOR and refinancing risk, data security, technology disruption, competition, acquisitions and integration, tax-law changes, and dependence on governmental incentives.
- Management stated that disclosure controls were effective and that no material changes affected internal control over financial reporting during the quarter. No material adverse legal proceedings were reported.
Investor verification checklist
- Verify whether revenue growth can be sustained while gross and operating margins recover from the Q2 and first-half declines.
- Reconcile the significant decline in operating cash flow with working-capital movements, employee and vendor payments, taxes, interest and subsidy timing.
- Assess leverage, maturities and interest-rate sensitivity after the August 2018 refinancing, including the impact of LIBOR changes.
- Monitor GE revenue trends, Global Client growth and customer concentration, including GE’s 10% share of first-half revenue.
- Evaluate the sustainability and tax treatment of Indian export subsidies and other government incentives.
- Review the closing, purchase price and integration risks associated with the planned Barkawi acquisition.
- Assess the effect of ASC 606 contract-cost capitalization on future SG&A, cash conversion and comparability with prior periods.