ExlService Holdings, Inc. — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011; results are unaudited and compared with the same 2010 periods. ExlService provides outsourcing and transformation services, primarily to clients in the United States and United Kingdom.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $100.0 million | $67.6 million | $258.0 million | $182.7 million |
| Gross profit | $38.3 million | $27.0 million | $100.0 million | $73.2 million |
| Operating income | $11.7 million | $7.0 million | $28.6 million | $18.7 million |
| Net income | $8.4 million | $7.8 million | $25.2 million | $18.3 million |
| Diluted EPS | $0.27 | $0.26 | $0.81 | $0.60 |
- Revenue grew 48.0% in Q3 and 41.2% year to date. Outsourcing revenue rose to $83.2 million in Q3, including $22.5 million from OPI and $10.2 million of net volume growth. Transformation revenue was $16.8 million in Q3, slightly below the prior year; nine-month revenue rose to $49.2 million.
- Gross margin declined to 38.3% from 40.0% in Q3 and to 38.8% from 40.1% year to date, which management primarily attributed to acquisitions. Operating margin improved to 11.7% from 10.3% in Q3 and to 11.1% from 10.3% year to date. Net margin was 8.4% versus 11.5% in Q3 and 9.8% versus 10.0% year to date.
- Income tax expense rose to $4.1 million in Q3 from $0.4 million; the effective tax rate increased to 33.0% from 4.7%. Year-to-date tax expense was $8.6 million versus $3.9 million, with the effective rate at 25.5% versus 17.5%. The increase chiefly reflected expiration of Indian tax holidays.
- Operating cash flow was $40.5 million for the nine months, versus $23.7 million. Investing cash outflow was $100.7 million, principally reflecting the OPI acquisition; financing cash inflow was $24.0 million, including public-offering proceeds. Cash and cash equivalents declined by $38.3 million to $72.9 million; short-term investments were $9.6 million.
- Current assets were $159.8 million and current liabilities $70.4 million at September 30. The company reported no revolver borrowings at quarter-end and had a $50 million three-year revolving credit facility. Capital lease obligations totaled $6.9 million; the filing reports no off-balance-sheet arrangements.
Material changes and significant items
- ExlService acquired OPI on May 31, 2011, to expand finance and accounting outsourcing. The preliminary purchase price was $100.9 million; OPI contributed $22.5 million of Q3 revenue and $1.6 million of Q3 net income after acquisition. Goodwill rose to $96.2 million from $43.4 million at year-end, primarily reflecting OPI.
- Q3 operating costs included a $3.1 million service-tax refund benefit. Nine-month outsourcing revenue included a $2.2 million one-time client payment with no associated costs. These items are not necessarily recurring.
- Other comprehensive loss was $18.9 million in Q3, mainly from foreign-currency translation and cash-flow hedge losses; accumulated other comprehensive loss was $16.5 million at quarter-end.
- The company completed a September public offering in which it sold 1.0 million primary shares and received net proceeds of $21.6 million; selling stockholders also sold 3.0 million shares.
- On October 1, 2011, after quarter-end, the company acquired Trumbull Services for $250,000 in cash, subject to working-capital adjustments.
Outlook, commentary and risks
- Management expects revenue to grow through expanded services and clients, organically and through acquisitions, but provided no specific revenue or earnings guidance in the supplied filing text.
- Management expected $6–$9 million of capital expenditures in the remainder of 2011, mainly for facilities and technology. It noted that future spending depends partly on new client contracts and growth in existing accounts.
- The Indian tax holiday expiration is expected to increase taxes from 2011 onward. The Philippine tax holiday was expected to expire in mid-2012 unless extended.
- Client concentration remains material: the three largest clients generated 29.2% of Q3 revenue. Travelers represented 10.7% of Q3 revenue and could terminate without cause on 60 days’ notice; Centrica represented 10.1% and its agreement was scheduled to expire in April 2012, with termination provisions. Management expected significant client concentration to continue in the near term.
- Indian tax authorities’ assessments and related disputes totaled $20.9 million, including interest. The company had deposited $11.2 million and provided $2.7 million in bank guarantees; management considered the probability of loss remote and recorded no accrual. Similar assessments for later years may arise.
- Other stated risks include acquisition integration, competition and pricing pressure, reliance on offshore operations and trained staff, foreign-exchange movements, changes to government incentives, and the short-term or terminable nature of some client work. Management said it hedges a substantial portion of certain currency exposures.
Key facts for investors to verify
- How much of revenue growth and future profitability is attributable to OPI and other acquisitions versus organic volume growth, and how acquisition integration is progressing.
- Whether gross margins recover as acquired operations are integrated, and the effect of tax-holiday expirations on the effective tax rate and earnings.
- Renewal, termination and volume terms for major client relationships, particularly Travelers and Centrica, and the company’s progress diversifying its client base.
- Developments in Indian transfer-pricing disputes, potential future assessments, and the status of deposits, guarantees and tax reserves.
- Cash conversion and working-capital trends, planned capital spending, lease commitments, and the use of the revolving facility for acquisitions or other needs.
- The final OPI purchase-price allocation and subsequent performance, as well as the financial contribution and integration costs of the post-quarter Trumbull acquisition.