Business Context and Reporting Period
Company: ExlService Holdings, Inc.
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2007
Business Overview: ExlService is a business solutions provider offering offshore business process outsourcing (BPO), research and analytics, and transformation services. The company primarily serves Global 1000 clients in the insurance, banking, financial services, utilities, healthcare, telecommunications, and transportation sectors. Operations are centered in India, with sales teams in the U.S. and U.K., and a new facility planned for the Philippines.
Key Financial Metrics
| Metric (in millions) | 2007 | 2006 |
|---|---|---|
| Total Revenues | $179.9 | $121.8 |
| Cost of Revenues | $113.7 | $73.8 |
| Gross Profit | $66.2 | $48.0 |
| Operating Income | $17.2 | $15.1 |
| Net Income to Common Stockholders | $27.0 | $13.4 |
| Diluted EPS | $0.93 | $0.58 |
| Cash and Cash Equivalents | $102.2 | $85.4 |
| Working Capital | $119.6 | $85.0 |
| Total Assets | $210.8 | $164.8 |
| Stockholders' Equity | $174.0 | $127.2 |
Margins: Gross margin decreased slightly from 39.4% in 2006 to 36.8% in 2007. Operating margin decreased from 12.4% to 9.6%. Net income margin increased from 11.0% to 15.0%.
Material Changes vs. Prior Period
- Revenue Growth: Total revenues increased 47.7% year-over-year, driven by organic growth, the addition of 38 new clients, and the full-year impact of the Inductis acquisition (completed July 2006).
- Profitability: Net income to common stockholders more than doubled (101.2% increase) to $27.0 million. This was significantly aided by a $7.7 million foreign exchange gain in 2007 compared to a $0.3 million loss in 2006.
- Cost Structure: Cost of revenues increased 54.0%, outpacing revenue growth due to higher employee salaries, recruitment, and training costs. SG&A expenses increased 60.7% due to public company compliance costs and expanded sales teams.
- Liquidity: Cash and cash equivalents grew to $102.2 million, supported by strong operating cash flows of $23.4 million.
Guidance, Outlook, Risks, and Contingencies
Management Commentary and Outlook
Management expects continued revenue growth through organic expansion and strategic acquisitions. The company plans to open a 900-workstation facility in the Philippines in April 2008. Capital expenditures are projected to be approximately $20.0 million in 2008 to support facility expansion and technology improvements.
Key Risks
- Client Concentration: Two clients, Norwich Union (27.0% of revenue) and Centrica (24.7% of revenue), accounted for 51.7% of total revenues in 2007. The loss of either would have a material adverse effect.
- Facility Transfer Option: Norwich Union holds an option to purchase the shares of the subsidiary operating ExlService's Pune, India facility (which generated 15.5% of 2007 revenue) between May 2008 and February 2011. Exercise of this option would result in a loss of revenue and employees.
- Employee Turnover: The billable employee turnover rate was 38.2% in 2007. High turnover increases recruitment and training costs, impacting profit margins.
- Foreign Exchange: Revenues are primarily in U.S. dollars and U.K. pounds, while expenses are in Indian rupees. Fluctuations in exchange rates significantly impact results.
- Tax Incentives: The company benefits from a ten-year Indian corporate income tax holiday expiring in 2009. Expiration will materially increase tax expenses.
Contingencies
Indian Tax Disputes: The company is contesting five assessment orders from Indian tax authorities regarding transfer pricing and permanent establishment status. Total amounts demanded are approximately $11.4 million. The company has deposited $4.3 million against these assessments but believes the probability of loss is remote and has not accrued a liability.
Investor Verification Checklist
- Verify the status of the Norwich Union "Transfer Option" regarding the Pune facility and any recent communications regarding its exercise.
- Monitor the renewal status of contracts with Norwich Union and Centrica, which represent over 50% of revenue.
- Assess the impact of the expiring Indian tax holiday (2009) on future effective tax rates and net income.
- Review the outcome of ongoing Indian tax authority audits regarding transfer pricing and permanent establishment.
- Track employee turnover rates and wage inflation in India to evaluate future margin pressure.
- Confirm the operational readiness and cost structure of the new Philippines facility scheduled for April 2008.