ExlService Holdings, Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Unaudited consolidated results; dollar amounts below are in millions unless stated otherwise. ExlService provides business process management and analytics services. Effective January 1, 2020, it reorganized reporting into Insurance, Healthcare, Emerging Business and Analytics; prior-period segment results were recast.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Revenue | $241.0 | $251.4 | $709.5 | $734.5 |
| Gross profit | $88.9 | $83.9 | $236.3 | $247.2 |
| Gross margin | 36.9% | 33.4% | 33.3% | 33.7% |
| Operating income | $34.4 | $22.4 | $71.8 | $53.1 |
| Operating margin | 14.3% | 8.9% | 10.1% | 7.2% |
| Net income | $26.4 | $19.0 | $57.3 | $46.3 |
| Diluted EPS | $0.76 | $0.55 | $1.65 | $1.33 |
- Revenue and segment trends: Q3 revenue fell 4.1% year over year; nine-month revenue fell 3.4%. In Q3, Analytics grew 2.0%, while Insurance declined 3.6%, Healthcare 2.0% and Emerging Business 18.2%. For the first nine months, Healthcare grew 10.8% and Analytics 0.4%; Insurance declined 2.0% and Emerging Business 19.8%.
- Cash flow: Nine-month operating cash flow was $126.3, versus $106.0 in 2019. Investing activities provided $11.1, compared with $21.3 used in 2019, largely reflecting net investment redemptions. Financing activities used $48.4. Cash, cash equivalents and restricted cash ended at $216.0, up from $127.0 at the start of the year.
- Liquidity and debt: Cash, cash equivalents and short-term investments totaled $362.6 at September 30, 2020. Borrowings were $226.7 gross ($216.2 long-term carrying value plus $10.5 current); subtracting cash and short-term investments implies approximately $135.9 of net cash. The company reported compliance with credit-facility covenants. Operating lease liabilities totaled $108.5 and are separate from borrowings.
- Capital spending and shareholder returns: Nine-month capital expenditures were $34.6. The company expected full-year 2020 capital expenditures of $36–38. It resumed repurchases July 1 after a temporary COVID-related suspension and targeted up to $80 of repurchases for calendar 2020, subject to market conditions; $24.9 was repurchased in Q3.
Changes, outlook and management commentary
- COVID-19 disrupted service delivery and client activity, including the transition to virtual work, lower volumes at some clients and delays in new-contract execution and implementation. Management said the pandemic’s ultimate effects remained uncertain and expected operations and growth to continue to be affected through 2020 and potentially beyond.
- Q3 margin and operating-profit improvement reflected lower employee, travel and other costs, including temporary pandemic cost measures. Nine-month gross margin was slightly lower year over year despite higher operating margin and income, aided in part by lower SG&A and the absence of 2019 impairment and restructuring charges.
- The company drew $100 of its credit line in March as a precaution and repaid it in full in April. It deferred $4.5 of employer FICA taxes under the CARES Act, payable half in December 2021 and half in December 2022. Discretionary 401(k) contributions were temporarily suspended from January through June and resumed retrospectively from August.
- No specific revenue or earnings guidance is provided in the supplied filing text. Management said it did not expect COVID-19 to materially adversely affect liquidity in the foreseeable future, while cautioning that future results and cash flows could differ materially.
Risks, contingencies and unusual items
- COVID-19, client concentration, offshore delivery and remote-work cybersecurity or operational failures are highlighted risks. The top ten clients generated 38.7% of Q3 revenue, versus 35.7% a year earlier; management said losing a top-ten client could materially harm performance.
- Indian tax disputes involve $16.6 of assessments net of advance payments as of September 30, 2020. The company had paid or provided bank guarantees for $8.0 and had not accrued a loss, stating it believes its position will be sustained. Potential additional assessments remain possible.
- A 2019 Indian judicial interpretation of employee benefit contributions could increase amounts payable if applied retrospectively; the company said it could not reliably estimate the timing or amount. Pending litigation losses, if any, could not be reasonably estimated; management did not expect currently pending matters to have a material adverse effect.
- The company reported no goodwill impairment in 2020 and no Q3 impairment trigger, but warned that COVID-19 and market conditions could change future impairment assumptions. Q3 2019 included a $0.5 restructuring charge; the first nine months of 2019 included $7.3 in impairment and restructuring charges related to the Health Integrated wind-down.
Important facts for investors to verify
- Whether revenue weakness, particularly in Emerging Business, continued after Q3 and how client volumes and contract ramps developed.
- Whether Q3 cost reductions and margin improvement were sustainable as temporary COVID-related measures were reversed or operating conditions changed.
- Actual 2020 capital expenditures and share repurchases versus the stated $36–38 capex expectation and up-to-$80 repurchase target.
- Cash generation, cash held in foreign jurisdictions, borrowings and covenant compliance; the filing notes $300.7 of cash and investments were located abroad and may be subject to taxes upon distribution.
- Developments in COVID-19-related operating risks, Indian tax disputes and the potential employee-benefit contribution exposure.