Genpact Limited 10-Q Summary: Second Quarter 2017
Business Context and Reporting Period
Genpact is a global professional services firm focused on digital transformation, business process outsourcing, analytics, technology and industry-specific solutions. It employed more than 77,000 people in over 20 countries. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2017, compared primarily with the corresponding 2016 periods.
Financial Performance and Position
| Metric | Three Months Ended June 30 | Six Months Ended June 30 |
|---|---|---|
| Net revenues | $670.7 million, up 6.4% | $1,293.7 million, up 4.3% |
| Gross profit | $255.4 million, up 3.5% | $495.1 million, up 2.4% |
| Gross margin | 38.1%, versus 39.1% | 38.3%, versus 39.0% |
| Income from operations | $80.0 million, essentially flat | $159.1 million, up 2.3% |
| Operating margin | 11.9%, versus 12.7% | 12.3%, versus 12.5% |
| Net income attributable to shareholders | $68.9 million, up 5.0% | $122.3 million, down 1.8% |
| Diluted EPS | $0.36, versus $0.31 | $0.62, versus $0.58 |
Global Client revenue increased 13.6% in the second quarter and 10.7% in the first half, while GE revenue declined 33.9% and 30.7%, respectively. Global Clients represented 90.6% of second-quarter revenue and 89.8% of first-half revenue. BPO revenue increased 9.0% in the quarter and 6.8% year to date; IT services revenue declined 4.7% and 6.0%, respectively.
Second-quarter net income benefited from $12.5 million of other income, primarily an Indian subsidiary subsidy. First-half net income also included $13.0 million of other income. Net interest expense increased to $9.9 million in the quarter and $15.3 million in the first half, reflecting higher LIBOR, increased revolver borrowings and interest on newly issued senior notes.
Net cash provided by operating activities was $115.3 million for the first half of 2017, versus $85.9 million in the prior-year period. Investing cash outflow was $245.4 million, primarily due to acquisitions, compared with $63.3 million in 2016. Financing cash flow was $127.9 million, including proceeds from debt issuance, offset by share repurchases and dividends. Cash and cash equivalents were $441.1 million at June 30, 2017, compared with $422.6 million at December 31, 2016.
At June 30, 2017, short-term borrowings were $205.0 million, current long-term debt was $39.2 million, and long-term debt excluding the current portion was $1.026 billion. Total debt was approximately $1.27 billion, excluding capital lease obligations. The company had $717.8 million outstanding under its term loan and $347.5 million of senior notes due April 2022. The revolving credit facility had $205.0 million of funded borrowings against a $350.0 million commitment. The company stated that it complied with applicable financial covenants.
Material Changes Versus the Prior Comparable Period
- Revenue growth was driven by Global Clients, BPO services and acquisitions, more than offsetting the planned decline in GE-related revenue.
- Gross margin declined 100 basis points in the second quarter and 70 basis points for the first half, primarily from wage inflation, higher operational headcount, infrastructure costs and revenue mix.
- Operating margin declined in both comparison periods despite modest operating-income growth.
- Net interest expense increased materially because of higher interest rates, greater revolver utilization and the March 2017 senior notes issuance.
- First-half operating cash flow improved, but acquisition spending increased investing cash outflows by $182.1 million year over year.
- The company repurchased $219.8 million of shares in the first half, including a $200.0 million accelerated share repurchase, and paid $23.5 million of dividends. Shares outstanding declined to 192.9 million at June 30.
- Goodwill increased from $1.069 billion at year-end 2016 to $1.261 billion at June 30, 2017, largely because of acquisitions and foreign-exchange effects.
Acquisitions, Outlook, Risks and Unusual Items
Genpact acquired RAGE Frameworks for estimated consideration of $125.1 million, BrightClaim for $56.4 million, the Fiserv Australia image-processing business for $19.0 million and LeaseDimensions for $11.6 million. These transactions expanded digital, artificial intelligence, insurance, financial-services, Australia, commercial-lending and leasing capabilities. A subsequent July 18, 2017 acquisition of Onsource LLC was disclosed at estimated cash consideration of $22.1 million.
No specific financial guidance was provided in the filing text. Management stated that cash from operations, cash reserves and debt capacity were expected to be sufficient to fund operations, growth, acquisitions, dividends and potential additional repurchases. Management also stated that revenue recognition under the new revenue standard was expected to remain largely unchanged, although contract-cost timing could be affected.
Key risks include client retention and new-business development, dependence on the United States, Europe and financial-services clients, declining GE revenue, pricing and utilization, wage inflation and employee retention, acquisitions and integration, foreign-exchange volatility, LIBOR and credit-rating changes, debt-service and covenant requirements, data security and technology disruptions, regulatory and tax changes, visa restrictions and intense competition.
Unusual or nonrecurring items included the Indian subsidy, gains from the sale of certain real property and liability write-backs, changes in acquisition earn-out fair values, and the absence in 2017 of the $5.8 million first-half 2016 intangible-asset impairment charge. The company also reported $24.1 million of unrecognized tax benefits at June 30, 2017, of which $23.1 million could affect the effective tax rate if recognized.
Foreign-currency and interest-rate exposure remains significant. At June 30, 2017, interest-rate swaps covered $444.5 million of notional debt, while outstanding foreign-exchange and interest-rate derivatives had aggregate notional amounts disclosed in the notes. The company reported $1.675 billion of total contractual obligations, including debt, leases, purchase obligations, capital commitments and earn-outs.
Important Facts for Investors to Verify
- Whether Global Client growth can continue to offset the ongoing decline in GE revenue.
- Whether wage inflation, infrastructure costs and mix changes continue to pressure gross and operating margins.
- The earnings and cash-flow contribution, integration progress and final purchase accounting for the 2017 acquisitions.
- Debt repayment capacity, floating-rate exposure, revolver utilization and compliance with credit-facility covenants.
- The sustainability of substantial share repurchases and the $0.06 quarterly dividend alongside acquisition spending and debt service.
- The impact of foreign-exchange movements, particularly involving the Indian rupee, euro, pound sterling and Australian dollar.
- Potential changes in unrecognized tax benefits, tax incentives and the effective tax rate.
- The final settlement of the $200.0 million accelerated share repurchase and its effect on diluted share count.
- Implementation of the revenue-recognition standard effective January 1, 2018 and the eventual effects of the new lease standard.