ExlService Holdings, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. Amounts below are in U.S. dollars; financial statement amounts are in millions unless noted. The company provides Operations Management and Analytics services, principally to clients in the U.S. and U.K.
Financial performance
- Revenue: Q3 revenue was $171.2 million, up 4.7% year over year; nine-month revenue was $508.7 million, up 10.0%.
- Segment trends: Q3 Operations Management revenue rose 1.2% to $129.6 million, while Analytics rose 17.4% to $41.6 million. For nine months, Operations Management grew 3.1% to $388.5 million and Analytics grew 40.3% to $120.2 million.
- Profit and margins: Q3 gross profit was $59.4 million (gross margin 34.7%, versus 36.9%); operating income was $17.4 million (operating margin 10.1%, versus 12.7%); net income was $16.1 million, or $0.46 diluted EPS, versus $15.2 million and $0.44. Nine-month gross profit was $176.5 million (34.7% margin), operating income $50.0 million (9.8% margin), and net income $46.2 million, or $1.34 diluted EPS.
- Cash flow: Nine-month operating cash flow was $56.0 million, compared with $54.6 million. Capital expenditures were $20.3 million. Investing cash outflow was $126.2 million and financing cash outflow was $34.2 million; cash and cash equivalents declined by $106.9 million to $98.4 million.
- Liquidity and debt: Cash, cash equivalents and short-term investments totaled $214.0 million at September 30, 2016, including $156.4 million held by foreign subsidiaries. Debt was $45.0 million, down from $70.0 million at year-end 2015, under a $100 million revolving facility maturing in October 2019. The company reported compliance with its debt covenants.
Changes versus prior comparable periods
- Revenue growth was led by Analytics, including acquired businesses and higher client volumes. Q3 revenue also included currency headwinds; nine-month growth included $12.3 million from the RPM and IQR acquisitions.
- Q3 cost of revenue increased 8.3%, faster than revenue growth, and gross profit fell 1.4%. Management cited employee costs, wage increases, higher average headcount, and lower revenue in consulting and platform businesses. Nine-month gross profit rose 6.5%, slower than revenue growth, and operating margin declined from 10.7% to 9.8%.
- Nine-month net income increased 25.7% year over year, supported by higher other income and foreign-exchange gains and a lower effective tax rate. Other income included a $4.1 million reversal of the RPM acquisition earn-out liability; the nine-month effective tax rate was 28.6%, versus 34.4%.
Outlook, commentary and risks
- No specific revenue or earnings guidance is provided in the filing. Management expects $5–$8 million in additional capital expenditures during the remainder of 2016 and expects operating cash flow to fund smaller acquisitions, capital spending and working capital; significant acquisition-led growth could require additional financing.
- Management expects Analytics revenue to grow as services and the client base expand, organically and through acquisitions. The filing also describes industry movement toward transaction- and outcome-based pricing and multi-vendor sourcing, which could pressure revenue and operating margins.
- In October 2016, after quarter-end, the company acquired Datasource Consulting for $18.8 million, subject to a working-capital adjustment, and issued restricted stock valued at $4.7 million to certain employees.
- Indian tax disputes involved aggregate demands of $20.5 million at September 30, 2016; $14.6 million had been paid or supported by bank guarantees. Management considered ultimate liability remote and recorded no accrual. Further assessments remain possible.
- Other risks include customer concentration (top ten clients generated 41.0% of Q3 revenue), foreign-exchange volatility including Brexit-related sterling uncertainty, competition and staffing, acquisition integration, and data-security or technology disruptions. The company said it had no material change in market-risk exposure beyond disclosures in the filing.
- Disclosure controls and procedures were assessed as effective; management reported no material change in internal control over financial reporting during the quarter.
Key facts for investors to verify
- Whether Analytics growth and the benefits of acquisitions are sustainable, and whether Operations Management margins stabilize.
- How wage, staffing, facility and technology costs compare with revenue growth, especially under transaction-based or multi-vendor contracts.
- Cash conversion and working-capital trends, the use and location of cash and investments, and funding needs following the Datasource acquisition.
- Final purchase accounting and integration outcomes for Liss and IQR, and the financial effects of the subsequent Datasource acquisition.
- Developments in Indian tax litigation, currency exposure and hedging, and any resulting cash, earnings or liquidity effects.