ExlService Holdings, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. The company provides business process management, operations management, consulting and analytics services, primarily to clients in the United States and United Kingdom. Financial results are unaudited and exclude the July 1 SCIO acquisition.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $210.1 million | $189.1 million | $417.1 million | $372.1 million |
| Gross margin | 33.5% | 34.6% | 33.4% | 34.7% |
| Operating income | $17.1 million | $18.3 million | $32.2 million | $35.5 million |
| Operating margin | 8.1% | 9.7% | 7.7% | 9.5% |
| Net income | $14.5 million | $20.4 million | $37.6 million | $37.2 million |
| Diluted EPS | $0.41 | $0.58 | $1.07 | $1.06 |
| Operating cash flow | Not separately stated for the quarter | $13.8 million | $45.1 million |
Q2 revenue increased 11.1%; first-half revenue increased 12.1%. Analytics and Insurance were major contributors to growth. Q2 gross margin fell 110 basis points and operating margin fell 160 basis points year over year. First-half gross margin declined 130 basis points. Healthcare margins weakened substantially, which management attributed to the Health Integrated acquisition and termination of certain client contracts; higher employee costs and wage inflation also contributed to cost growth. First-half net income was broadly flat despite lower operating income, helped by lower income tax expense.
Liquidity, debt and capital allocation
- At June 30, cash, cash equivalents and restricted cash totaled $90.0 million; short-term investments were $149.0 million. Current assets were $426.7 million and current liabilities $119.6 million.
- Reported borrowings were $67.0 million, up from $60.0 million at year-end 2017. The company reported compliance with credit-facility covenants. Its $200 million revolving facility could be increased by up to $100 million.
- First-half operating cash flow fell $31.3 million year over year, primarily reflecting higher working capital, including increased receivables and advance taxes and lower accrued employee costs and accounts payable. Capital expenditures were $19.3 million.
- The company repurchased $20.3 million of shares under its repurchase program during the first half. It forecast 2018 capital expenditures of $35–$40 million.
Outlook, material events and risks
- SCIO acquisition: On July 1, the company completed its acquisition of SCIOInspire Holdings for $236.5 million, subject to post-closing adjustments. It funded the purchase with $233 million from the credit facility and the remainder from cash. On July 2, it increased revolving commitments to $300 million to support funding. Purchase-price allocation and pro forma financial information were not yet available. Management said the acquisition is expected to strengthen Payment Integrity and Care Management.
- Guidance: The filing provides no revenue or earnings forecast. Management expects 2018 capital expenditures of $35–$40 million and expects to use operating cash flow for ongoing investment, smaller acquisitions and working capital.
- Taxes: The first-half effective tax rate was 2.7%, including a $4.8 million reduction in the provisional U.S. transition-tax estimate and stock-award tax benefits. The company said its accounting for certain Tax Reform Act effects remained incomplete. Q2’s effective tax rate was 27.5%, compared with 3.9% a year earlier, largely reflecting prior-year discrete tax benefits.
- Contingencies: Indian tax authorities disputed $17.4 million of transfer-pricing and permanent-establishment assessments; the company had paid or secured $8.3 million and had not accrued for the claims, believing its position would be sustained. A $2.4 million settlement of a California putative class action was accrued, subject to final court approval.
- Business risks: The top ten clients represented about 39% of revenue. The company cited client concentration, competition and pricing pressure, hiring and retention, foreign-exchange exposure, cybersecurity, acquisition integration, and Indian tax disputes among its risks. It also noted a shift toward transaction- and outcome-based pricing, which may pressure margins.
- Other notable item: Accumulated other comprehensive loss increased to $87.6 million from $45.7 million at year-end, primarily reflecting foreign-currency translation and cash-flow hedge movements.
Key facts for investors to verify
- Whether SCIO integration, acquisition financing and subsequent debt levels affect margins, cash flow and covenant headroom.
- Whether operating cash flow recovers from the working-capital-driven first-half decline, and how planned capital spending develops.
- Whether Healthcare profitability improves after contract exits and the Health Integrated integration; monitor margin trends in Analytics and other segments.
- Progress and final outcomes of Indian tax disputes and the California settlement approval, along with completion of Tax Reform Act accounting.
- Client concentration, foreign-exchange and hedge exposures, and actual performance against the stated capital-expenditure outlook.