ExlService Holdings, Inc. — Q2 2013 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2013. Amounts are in U.S. dollars; financial statement amounts below are in millions unless stated otherwise. ExlService provides outsourcing and transformation services, principally to clients in the United States and United Kingdom. The filing is unaudited.
Financial results and liquidity
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Revenue | $116.0 | $108.0 | $232.0 | $212.6 |
| Gross profit / gross margin | $42.1 / 36.3% | $42.0 / 38.9% | $85.2 / 36.7% | $79.9 / 37.6% |
| Operating income / margin | $12.8 / 11.1% | $14.4 / 13.3% | $24.9 / 10.7% | $24.8 / 11.7% |
| Net income / net margin | $9.2 / 8.0% | $9.1 / 8.4% | $19.0 / 8.2% | $18.0 / 8.5% |
| Diluted EPS | $0.27 | $0.27 | $0.56 | $0.55 |
- Q2 revenue rose 7.4%; outsourcing revenue increased 9.5% to $97.3 million, while transformation revenue declined 2.2% to $18.7 million. First-half revenue rose 9.1%, with both segments growing.
- First-half operating cash flow was $25.4 million, compared with $19.5 million. Investing cash outflow was $11.3 million, including $10.3 million of capital expenditures and $1.2 million paid for Landacorp working-capital adjustments. Financing cash flow was $1.3 million. Cash and cash equivalents increased to $114.6 million; cash plus short-term investments totaled $120.2 million.
- At June 30, current assets were $217.1 million and current liabilities $65.3 million. The reported balance sheet implies a current ratio of approximately 3.3. Total liabilities were $83.4 million. The company had no credit-facility borrowings; capital lease obligations totaled $3.4 million.
- Other comprehensive loss was $23.2 million in Q2, mainly from foreign-currency translation and cash-flow hedge losses; total comprehensive loss was $14.0 million despite positive net income.
Material changes and management commentary
- Revenue growth was led by outsourcing, including $4.4 million of Q2 revenue from the Landacorp acquisition and net volume growth from existing and new clients. Currency movements partially offset growth. Transformation revenue fell in Q2 amid lower discretionary spending on project work; first-half growth reflected more annuity decision-analytics work and project engagements.
- Gross margin declined year over year in both periods. Management cited higher employee and operating costs and lower utilization in transformation services, partly offset by Landacorp’s higher gross margins and currency effects. Q2 operating income declined 10.9%; first-half operating income was nearly flat as revenue growth was offset by margin pressure and higher selling, general and administrative costs.
- Landacorp, acquired in October 2012 for a total purchase price of $38.7 million, expanded healthcare capabilities. Purchase accounting was revised and remained incomplete pending assessment of acquired tax-loss realizability; $5.5 million of related deferred tax assets was recorded.
- Management expected to incur another $10–$15 million of capital expenditures in the remainder of 2013, mainly for facilities and technology to support client growth. No full-year revenue or earnings guidance is provided in the filing. Management expects to rely on operating cash flow for routine investment and smaller acquisitions; significant acquisition-led growth could require additional financing.
- Days sales outstanding increased to 59 days from 56 at December 31, 2012. The company said it intended to permanently reinvest overseas earnings; $66.7 million of cash and short-term investments was held by foreign subsidiaries.
Risks, contingencies and unusual items
- Client concentration remains significant: the top ten clients generated 59.6% of revenue in both Q2 and the first half. No single client exceeded 10% of 2013 revenue. Management expects a significant portion of revenue to continue coming from a limited number of large clients.
- Foreign exchange is a material exposure, principally to the Indian rupee and U.K. pound, with additional exposure to other operating currencies. Derivative liabilities were $14.8 million at June 30; management estimated $9.2 million of net derivative losses in accumulated other comprehensive income could be reclassified into earnings within 12 months.
- Indian tax authorities disputed transfer-pricing and permanent-establishment matters, with aggregate demands of $15.6 million at June 30. The company had paid or provided bank guarantees totaling $13.6 million and recorded no accrual, stating that ultimate liability was considered remote based on adviser input. Further assessments remain possible.
- Tax incentives are subject to eligibility and government action. The filing notes potential tax increases if Philippine tax holidays are changed or withdrawn, and an expected increase in tax expense as Indian tax incentives expire.
- Other stated risks include reliance on large clients, competition and pricing pressure, recruiting and retaining personnel, acquisition integration, international operations, technology or telecommunications disruption, data confidentiality, and regulatory or political changes. The company reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether revenue growth can continue without further deterioration in gross and operating margins, especially in transformation services.
- Client concentration, new-client conversion and the timing of anticipated revenue from the client acquired during the quarter that had not yet generated revenue.
- Landacorp integration, purchase-accounting completion, and the realizability of its acquired tax-loss deferred tax assets.
- Foreign-exchange exposure, hedge liabilities and the timing and earnings impact of expected hedge-loss reclassifications.
- Developments in Indian tax disputes, potential additional assessments, and the status of tax holidays and other incentives.
- Actual capital spending versus the stated remainder-of-2013 range and the continued trend in receivables and days sales outstanding.