ExlService Holdings, Inc. — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019. Unaudited consolidated financial statements; amounts below are in U.S. dollars unless stated otherwise. ExlService provides business process management, operations management, consulting, and analytics services, primarily to clients in the U.S. and U.K.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $251.4M | $231.1M | $734.5M | $648.2M |
| Gross profit / margin | $83.9M / 33.4% | $79.0M / 34.2% | $247.2M / 33.7% | $218.3M / 33.7% |
| Operating income / margin | $22.4M / 8.9% | $19.7M / 8.5% | $53.1M / 7.2% | $51.9M / 8.0% |
| Net income | $19.0M | $15.2M | $46.3M | $52.9M |
| Diluted EPS | $0.55 | $0.43 | $1.33 | $1.50 |
| Operating cash flow | Not presented quarterly in the supplied filing text | $106.0M | $47.2M |
- Q3 revenue rose 8.8%; nine-month revenue rose 13.3%. Nine-month growth included $37.9M of SCIO acquisition revenue for the first six months of 2019, plus organic growth in Analytics.
- Analytics revenue increased 7.3% in Q3 and 32.2% year to date. Insurance grew 20.9% in Q3 and 13.5% year to date. Year-to-date declines in All Other (15.0%) and TT&L (2.6%) partially offset growth.
- Q3 net income increased 24.9%, supported by higher operating income and other income. Nine-month net income fell 12.4%, primarily reflecting higher interest and tax expense; operating income increased only 2.4%.
- Other income included mutual-fund gains of $3.2M for Q3 and $10.1M year to date. Q3 also included $0.8M of one-time other income related to Health Integrated.
Financial position, debt, and liquidity
- At September 30, cash and cash equivalents were $101.4M, short-term investments $179.3M, and restricted cash $7.9M. Cash, cash equivalents, and restricted cash totaled $109.3M; cash plus short-term investments was $280.8M.
- Total assets were $1.146B and total equity $647.7M. Current assets were $506.2M and current liabilities $187.9M.
- Borrowings had $260.4M total principal outstanding: $150.0M of 3.50% convertible notes due 2024, $109.0M drawn on the revolver, and $1.4M in structured payables. The balance sheet presents $244.8M of borrowings after applicable accounting discounts and classification. Revolver debt declined from $150.0M at year-end 2018. The company reported compliance with debt covenants.
- Nine-month investing cash outflow was $21.3M, including $32.3M of capital expenditures; financing cash outflow was $77.7M, including $87.8M of borrowing repayments and $35.9M of treasury-stock purchases.
Material changes and management commentary
- Gross margin was down 80 basis points in Q3, though flat year to date. Healthcare margins weakened, partly from Health Integrated losses and start-up costs for new clients. Q3 All Other margin also declined amid lower Consulting and Utilities revenue.
- Operating lease accounting adoption added $88.8M of right-of-use assets and $99.6M of lease liabilities at September 30; the company said adoption did not materially affect income or cash flows.
- The company began substantially winding down Health Integrated on March 29, 2019, with completion expected by year-end 2019. It recorded $4.1M of restructuring costs and $3.2M of impairment charges year to date; total expected wind-down costs were $5.5M. Management cautioned that additional costs could arise.
- Management expects 2019 capital expenditures of $38M–$42M, primarily for facilities, technology, product development, automation, and infrastructure. No revenue or earnings guidance is provided in the supplied filing text.
- Top ten clients generated 35.7% of Q3 revenue and 36.2% for the first nine months. Management cautioned that losing any of its ten largest clients could materially adversely affect performance. Multi-vendor competition and alternative pricing models may pressure revenue and gross margins.
Risks, contingencies, and unusual items
- Indian tax authorities’ demands, primarily involving transfer pricing and permanent-establishment disputes, totaled $16.1M net of advance payments; $8.1M was covered by payments or bank guarantees. The company had not accrued a liability, believing its position was more likely than not to be sustained; further assessments are possible.
- A 2019 Indian judicial pronouncement concerning statutory defined-contribution payments could increase past-period obligations if applied retrospectively. The company said it could not reliably estimate the timing or amount.
- Foreign-exchange exposure includes the Indian rupee, U.K. pound, and Philippine peso. The company reported $409.7M of outstanding cash-flow hedges at quarter-end.
- Other risks cited include client concentration, hiring and retention, acquisitions, winding down businesses, technology and cybersecurity disruptions, regulatory and tax changes, and the ability to service debt. Management stated pending litigation was not expected to have a material adverse effect, but possible losses could not be reasonably estimated.
Investor facts to verify
- Whether Analytics and Insurance growth continues and offsets weakness in All Other, TT&L, and Health Integrated.
- Whether gross margins stabilize, particularly in Healthcare, and whether new-client start-up costs and wage inflation remain elevated.
- Whether Health Integrated’s wind-down is completed by year-end within the estimated $5.5M cost, and whether additional impairment or restructuring charges arise.
- Cash conversion, receivables and unbilled receivables ($80.6M at September 30), and the sustainability of the higher year-to-date operating cash flow.
- Debt repayment, interest expense, convertible-note terms and potential dilution, alongside cash held abroad that may be subject to taxes if distributed.
- Developments in Indian tax disputes and the uncertain potential impact of the Indian employee-benefit ruling.