Genpact Limited — 2018 Q3 Form 10-Q Summary
Business context and reporting period
Genpact is a global professional services company providing digitally led innovation, 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 nine months ended September 30, 2018, with comparative periods ended September 30, 2017.
Key financial metrics
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Net revenues | $748.0 million | $708.8 million | $2,165.5 million | $2,002.5 million |
| Gross profit | $266.6 million | $280.0 million | $776.8 million | $775.9 million |
| Gross margin | 35.6% | 39.5% | 35.9% | 38.7% |
| Income from operations | $94.0 million | $97.9 million | $237.3 million | $258.0 million |
| Operating margin | 12.6% | 13.8% | 11.0% | 12.9% |
| Net income attributable to shareholders | $73.6 million | $73.7 million | $202.9 million | $196.0 million |
| Diluted EPS | $0.38 | $0.38 | $1.04 | $0.99 |
Net cash provided by operating activities was $202.8 million for the first nine months of 2018, compared with $263.7 million in the prior-year period. Capital expenditures were $68.0 million, internally generated intangible asset spending was $19.4 million, and acquisition payments were $108.1 million. Net cash used in investing activities was $199.8 million. Net cash used in financing activities was $52.1 million, including $42.9 million of dividends and $130.1 million of share repurchases.
Cash and cash equivalents declined to $401.2 million at September 30, 2018 from $504.5 million at December 31, 2017. Accounts receivable were $710.0 million. Total debt consisted of $330.0 million of short-term borrowings, $33.5 million of current long-term debt and $983.9 million of long-term debt. Total shareholders’ equity was $1.285 billion.
Material changes versus the prior comparable period
- Q3 revenue increased 5.5% and nine-month revenue increased 8.1%. Global Client revenue increased 7.3% in Q3 and 10.0% for the first nine months, while GE revenue declined 10.5% and 8.1%, respectively.
- BPO revenue increased 6.8% in Q3 and 9.2% for the first nine months; IT services revenue was essentially flat in Q3 and increased 3.1% year to date.
- Profitability weakened: Q3 gross margin fell 390 basis points and nine-month gross margin fell 280 basis points. Management cited wage inflation, higher operational and onshore staffing costs, acquisitions, foreign exchange impacts and increased stock-based compensation.
- Q3 operating income declined 4.0%; nine-month operating income declined 8.0%. SG&A as a percentage of revenue improved, partially offsetting gross-margin pressure.
- The effective tax rate increased to 24.7% in Q3 from 18.4% and to 20.8% for the first nine months from 18.4%, driven by Tax Act-related items, partial expiration of Indian tax holidays and changes in income mix.
- Average headcount increased 6.5% in Q3 and 4.5% for the first nine months. The company completed acquisitions of Barkawi and Commonwealth Informatics in 2018 and purchased the remaining 49% of Strategic Sourcing Excellence.
- The company adopted ASC 606 using the modified retrospective method. Opening retained earnings increased by $17.9 million, and contract cost assets of $160.1 million were recognized at September 30, 2018. The adoption had no reported impact on revenue or cash flow for the periods presented, but increased reported Q3 and nine-month net income by approximately $1.3 million and $2.6 million, respectively, compared with results without adoption.
- The quarterly dividend increased 25% to $0.075 per share from $0.06 per share. The company repurchased $130.1 million of shares during the first nine months but made no repurchases during Q3; approximately $328 million remained authorized at September 30.
Guidance, outlook, commentary, risks and unusual items
The filing does not provide a clear formal revenue or earnings guidance range. Management stated that operating cash flow, cash reserves and debt capacity were expected to be sufficient to fund operations, expansion, acquisitions, dividends and potential additional repurchases.
- Management expects continued needs for working capital, delivery-center expansion, acquisitions and capability investments. Approximately $399.0 million of cash was held by non-Bermuda subsidiaries, including $300.0 million described as indefinitely reinvested.
- In August 2018, the credit facility was amended: the term loan was $680.0 million and the revolving facility increased from $350.0 million to $500.0 million, with maturity extended to August 8, 2023. Borrowings generally bear interest at LIBOR plus 1.375%, subject to ratings-based adjustments.
- The company had $350.0 million of 3.70% senior notes outstanding, due April 1, 2022. It completed the exchange offer for registered notes in July 2018.
- Material risks include client retention and concentration, including GE; pricing and utilization; wage inflation and employee attrition; foreign exchange; LIBOR and credit-rating changes; data security and privacy; technology disruptions; acquisition integration; competition; tax-law and government-incentive changes; offshore-services restrictions; and global economic conditions.
- Q3 included $5.2 million of government incentives, primarily an Indian export subsidy, and a $5.3 million gain from remeasurement of acquisition-related earn-out consideration. The company also recorded a $0.7 million asset impairment in Q3 and $1.5 million for the first nine months.
- Other comprehensive loss attributable to shareholders was $86.4 million in Q3 and $215.1 million for the first nine months, largely reflecting currency translation and cash-flow-hedge losses.
- Total contractual obligations were approximately $1.932 billion, including $1.169 billion of long-term debt obligations, $333.1 million of short-term borrowings, $258.1 million of operating leases and $100.5 million of other liabilities.
Most important facts for investors to verify
- Whether revenue growth from Global Clients can offset continued declines in GE-related revenue.
- Whether gross-margin pressure from wage inflation, onshore delivery costs, foreign exchange and acquisitions moderates.
- The sustainability and cash-flow impact of the Indian export subsidy and other government incentives.
- Liquidity, debt maturities, LIBOR sensitivity, covenant compliance and the concentration of cash in foreign subsidiaries.
- Integration results and incremental profitability from Barkawi, Commonwealth Informatics and other acquisitions.
- The effects of ASC 606 contract-cost capitalization and the upcoming adoption of lease accounting, which management expected to materially affect the financial statements.
- Execution against the share-repurchase and dividend programs while maintaining investment capacity and debt service.
- Potential tax exposure, including $22.7 million of unrecognized tax benefits at September 30, 2018, of which $21.5 million could affect the effective tax rate if recognized.