EXLS

ExlService Holdings, Inc. - 10-Q Summary (Q2 2007)

Business Context and Reporting Period

This filing covers the quarterly period ended June 30, 2007. ExlService Holdings, Inc. is a provider of offshore solutions, including Business Process Outsourcing (BPO), research and analytics, and advisory services. The company serves clients primarily in the United States and the United Kingdom. The reporting period includes the full impact of the Inductis Inc. acquisition completed on July 1, 2006, which expanded the company's research and analytics capabilities.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 70.6% year-over-year for the quarter and 77.1% for the six-month period. Growth was driven by the Inductis acquisition, organic growth in BPO and advisory services, and a stronger U.K. pound sterling.
• Profitability: Net income to common stockholders surged 300% for the quarter and 223.5% for the six-month period compared to 2006. This was aided by significant foreign exchange gains ($2.29 million for the quarter) and reduced interest expenses following the repayment of preferred stock and senior notes in late 2006.
• Operating Expenses: SG&A expenses increased 104.7% for the quarter, largely due to the addition of Inductis operations, increased professional fees associated with being a public company, and higher personnel costs.
• Cash Flow: Net cash provided by operating activities decreased to $1.12 million for the six months ended June 30, 2007, from $2.70 million in the prior year period, primarily due to tax payments and timing of vendor payments.

Guidance, Outlook, and Risks

• Client Concentration Risk: The company remains highly dependent on a few large clients. Norwich Union and Centrica plc accounted for approximately 54% of total revenues in the quarter. Norwich Union has a "Transfer Option" to assume operations of a facility in Pune, India, which could result in revenue loss if exercised.
• Foreign Exchange: The company is exposed to fluctuations between the U.S. dollar, U.K. pound sterling, and Indian rupee. While hedging strategies are in place, significant currency movements could materially impact results.
• Tax Contingencies: The company is involved in disputes with Indian tax authorities regarding transfer pricing and permanent establishment status. Three assessment orders totaling approximately $10 million in additional taxes have been issued. The company has deposited $4.2 million against these assessments but believes the probability of loss is remote and has not accrued a liability.
• Internal Controls: Management concluded that disclosure controls and procedures were not effective as of June 30, 2007, due to insufficient staffing, lack of automation, and integration complexities with Inductis. Remediation plans are underway.
• Capital Expenditures: The company expects to incur $11.0 million to $15.0 million in capital expenditures in 2007 to support growth, including a new facility in Noida, India.

Investor Verification Checklist

• Verify Norwich Union Contract Status: Confirm the likelihood and timing of the "Transfer Option" exercise regarding the Pune facility, which represents a significant portion of revenue.
• Review Tax Dispute Progress: Monitor the status of the Indian tax assessments totaling $10 million and the potential for additional deposits or liability accruals.
• Assess Internal Control Remediation: Track the progress of hiring, automation, and process reengineering to ensure disclosure controls become effective in future quarters.
• Monitor Currency Hedging: Evaluate the effectiveness of forward exchange contracts in mitigating the impact of the Indian rupee and U.K. pound sterling volatility.
• Check Client Diversification: Review the pipeline for new clients to reduce reliance on the top two customers who generate over 50% of revenue.