ExlService Holdings, Inc. — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013; unaudited. Comparisons are with Q1 2012 unless stated otherwise. Dollar amounts below are in millions unless noted.
Business context and reporting period
ExlService provides outsourcing and transformation services, principally to global clients in insurance, healthcare, utilities, banking and financial services, and related sectors. Its clients are primarily in the U.S. and U.K. The October 2012 Landacorp acquisition added healthcare technology and care-management capabilities and is reported in outsourcing services.
Financial performance and liquidity
| Metric | Q1 2013 | Q1 2012 / comparison |
|---|---|---|
| Revenue | $116.0 | $104.6; up 10.9% |
| Gross profit / margin | $43.1 / 37.1% | $37.9 / 36.3% |
| Operating income / margin | $11.8 / 10.2% | $10.4 / 10.0% |
| Net income / margin | $9.8 / 8.4% | $8.9 / 8.5%; net income up 9.5% |
| Diluted EPS | $0.29 | $0.27 |
| Cash from operations | $6.6 | $4.4 |
| Cash and cash equivalents at quarter-end | $102.3 | $82.3 at March 31, 2012 |
Outsourcing revenue was $97.6 million, up from $89.7 million; transformation revenue was $18.4 million, up from $14.9 million. The effective tax rate declined to 23.5% from 25.3%, while reported tax expense was approximately $3.0 million in both periods.
At March 31, 2013, cash, cash equivalents and short-term investments totaled approximately $108.6 million, including $58.4 million held by foreign subsidiaries. The company reported no borrowings under its $15 million revolving credit facility. Capital lease obligations were $4.0 million; total liabilities were $74.3 million. Q1 capital expenditures were $6.6 million, approximately equal to operating cash flow. Investing activities used $7.8 million, including $1.2 million for the Landacorp working-capital adjustment.
Material changes versus the prior comparable period
- Revenue growth reflected $4.3 million from Landacorp, $5.9 million of net volume increases from existing and new clients, and stronger transformation services; currency movements reduced outsourcing revenue by approximately $2.4 million.
- Gross margin improved by 0.8 percentage points, while operating margin improved by 0.2 points. SG&A rose 17.3% to $24.8 million, faster than revenue, partly due to Landacorp and continued investment in sales and client-management staff.
- Foreign exchange results shifted from a $1.1 million gain in Q1 2012 to a small loss in Q1 2013. Higher operating income was partly offset by the decline in other income, leaving net margin slightly lower.
- Operating cash flow increased $2.3 million year over year. Cash and cash equivalents declined $0.7 million during Q1 2013, compared with a $0.1 million decline in Q1 2012.
Outlook, commentary, risks and unusual items
- Management expects to use operating cash flow for business expansion and anticipates $15–$20 million of capital expenditures during the remainder of 2013, mainly for facilities, technology and infrastructure. The filing provides no specific full-year revenue or earnings guidance.
- Management expects growth from expanded offerings, client relationships and acquisitions. It cautions that project-based transformation work, long sales cycles, contract termination provisions and changing service volumes can make revenue variable.
- Client concentration remains material: the top ten clients generated 59.7% of Q1 2013 revenue. The U.S. and U.K. generated approximately 71.7% and 20.8%, respectively.
- Foreign-exchange exposure is principally to the Indian rupee and U.K. pound, with additional exposures in other operating currencies. Outstanding foreign-exchange contracts had notional amounts of approximately $240.8 million and GBP 13.0 million at quarter-end. The company estimated $3.2 million of net derivative losses in accumulated other comprehensive income could be reclassified to earnings within 12 months.
- Philippines tax holidays and Indian tax incentives are subject to eligibility, extension and regulatory conditions. Management says denial or loss of Philippine tax-holiday benefits could increase tax expense.
- Indian tax authorities disputed transfer-pricing and permanent-establishment matters with aggregate demands of $18.9 million at March 31, 2013. The company had paid or provided bank guarantees totaling $14.9 million, including $12.5 million in deposits and $2.4 million in restricted cash. Management considers ultimate liability remote and recorded no accrual; additional assessments remain possible.
- Landacorp purchase accounting remained incomplete, including final assessment of acquired tax losses and intangible valuations. The company recognized approximately $5.7 million of deferred tax assets related to acquired U.S. net operating losses.
- Other disclosed risks include client retention and concentration, hiring and retention of trained staff, competition and pricing pressure, offshore-outsourcing sentiment, technology or telecommunications disruption, data security, acquisition integration, and political or regulatory developments. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Most important facts for investors to verify
- Whether organic growth and transformation-services momentum continue, separating them from Landacorp contributions and currency effects.
- Whether margin performance can withstand faster SG&A growth, wage and staffing costs, pricing changes and transaction-based contract models.
- Whether operating cash flow covers planned capital spending and any acquisition needs, and how working-capital movements affect cash conversion.
- Developments in Indian tax disputes and Philippine tax-holiday extensions, including any change to management’s no-accrual assessment.
- Client concentration, foreign-exchange exposure and hedge-related losses that may flow from accumulated other comprehensive income into earnings.