Business context and reporting period
ExlService Holdings, Inc. (EXL) filed this Form 10-K for the fiscal year ended December 31, 2014. The filing provides full-year results and unaudited fourth-quarter data; it is not a standalone quarterly filing. EXL provides business process solutions through Operations Management and Analytics and Business Transformation. Amounts below are in U.S. dollars.
Financial performance and liquidity
| Metric | FY 2014 | FY 2013 | Change |
|---|---|---|---|
| Revenue, net | $499.3 million | $478.5 million | Up 4.4% |
| Gross profit / margin | $166.7 million / 33.4% | $187.5 million / 39.2% | Profit down 11.1% |
| Operating income / margin | $34.0 million / 6.8% | $67.4 million / 14.1% | Down 49.5% |
| Net income / margin | $32.4 million / 6.5% | $48.1 million / 10.1% | Down 32.6% |
| Diluted EPS | $0.96 | $1.42 | Down |
| Cash from operations | $66.7 million | $82.8 million | Down $16.1 million |
| Cash and cash equivalents | $176.5 million | $148.1 million | Up |
| Working capital | $211.4 million | $176.6 million | Up |
| Long-term borrowings | $50.0 million | None reported | New borrowing |
Short-term investments were $11.6 million, bringing cash, cash equivalents and short-term investments to $188.1 million. Net cash used in investing was $88.3 million, including $58.2 million net cash paid for acquisitions and $27.7 million of capital expenditures. The company reported no off-balance-sheet arrangements.
By segment, Operations Management revenue was $388.7 million, down 1.6%; Analytics and Business Transformation revenue was $110.6 million, up 32.5%. For Q4 2014, revenue was $135.3 million, gross profit $43.9 million and net income $7.5 million, compared with $124.1 million, $52.1 million and $15.9 million, respectively, in Q4 2013.
Material changes versus the prior comparable period
- Revenue growth was more than offset by weaker profitability: cost of revenue rose 14.3%, faster than revenue, and gross margin fell 5.8 percentage points.
- EXL recorded $26.3 million of reimbursements to Travelers as a reduction of revenue in 2014, compared with $0.3 million in 2013. Travelers revenue fell to $8.2 million from $46.2 million as services transitioned away.
- Operations Management revenue also reflected $12.2 million from Overland and $22.5 million of net volume gains from existing and new clients; these partially offset the Travelers decline and currency effects.
- Analytics and Business Transformation growth reflected stronger analytics engagements, consulting and finance transformation, including Blue Slate. The segment represented 22% of 2014 revenue.
- EXL acquired Blue Slate on July 1 and Overland on October 24, 2014. Their reported 2014 revenue contributions were $4.4 million and $12.2 million, respectively.
- Operating cash flow declined, while investing outflows increased substantially due primarily to the acquisitions and higher capital spending.
Outlook, commentary, risks and unusual items
- No specific revenue or earnings guidance for 2015 is provided in the filing. Management anticipated 2015 capital expenditures of $20 million to $25 million and expected to continue investing in global delivery capacity, technology, BPaaS and analytics capabilities.
- Management cited the Travelers transition and related reimbursements as important drags on 2014 results. The filing notes that transition services could continue for up to 18 months and that an unsatisfactory disentanglement could cause further costs or revenue loss.
- Revenue concentration remains significant: the top ten clients generated 50.3% of 2014 revenue, down from 57.9%; no single client exceeded 10%. Management warned that losing a major client could materially harm performance.
- Employee attrition for employees with more than 180 days of service rose to 32.3% from 25.8%, creating recruiting, training and margin risks. Wage inflation, utilization, pricing pressure and a shift toward transaction- or outcome-based contracts are also risks.
- Foreign exchange exposure is material because much revenue is denominated in U.S. dollars and pounds sterling while substantial costs are in Indian rupees and Philippine pesos. EXL hedges exposures, but the filing cautions that hedging may not fully offset currency movements.
- Tax benefits and disputes warrant attention. The effective tax rate fell to 13.8% from 26.0%, partly due to a $2.2 million reversal of an unrecognized tax benefit and a tax benefit associated with Travelers-related U.S. losses. Management warned that expiring India and Philippines tax incentives may raise future tax expense.
- Indian tax authorities disputed transfer-pricing and permanent-establishment positions, with aggregate demands of $22.9 million at year-end; $14.7 million had been paid or covered by bank guarantees. Management considered the likelihood of ultimate liability remote and recorded no provision. A further $1.2 million demand was received after year-end.
- After year-end, EXL agreed to acquire RPM Direct and RPM Data Solutions for $47 million cash at closing, up to $23 million contingent consideration and $4.15 million in restricted stock. It also increased its credit commitments by $50 million, bringing the facility to $100 million.
- The company reported effective disclosure controls and internal control over financial reporting; the independent auditor issued unqualified opinions. Controls of the 2014 acquisitions were excluded from the year-end assessment.
Important facts for investors to verify
- How much of revenue and margin performance reflects underlying operations versus the Travelers reimbursement and service transition?
- Whether the improvement in Analytics and Business Transformation can continue and offset pressure in Operations Management.
- Integration progress and returns from Blue Slate and Overland, including finalization of Overland’s purchase-price allocation and the impact of goodwill and acquired intangibles.
- Cash conversion, working-capital trends, acquisition spending and the company’s use of the expanded credit facility.
- Client concentration, employee attrition and wage trends, foreign-exchange exposures, tax incentive expirations and the outcome of Indian tax disputes.
- The purchase terms, performance conditions and financing for the subsequent RPM acquisition.