ExlService Holdings, Inc. — Q3 2018 Form 10-Q
Business context and reporting period. ExlService provides business process management (BPM), operations management, and analytics services. This unaudited filing covers the three and nine months ended September 30, 2018; financial amounts below are in millions unless stated otherwise. The July 1 acquisition of SCIO is included in results from that date.
Key financial results
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $231.1 | $192.3 | $648.2 | $564.4 |
| Gross profit / margin | $79.0 / 34.2% | $69.3 / 36.0% | $218.3 / 33.7% | $198.6 / 35.2% |
| Operating income / margin | $19.7 / 8.5% | $20.9 / 10.9% | $51.9 / 8.0% | $56.4 / 10.0% |
| Net income attributable to shareholders | $15.2 | $21.1 | $52.9 | $58.2 |
| Diluted EPS | $0.43 | $0.60 | $1.50 | $1.66 |
| Operating cash flow | Not stated quarterly | Not stated quarterly | $46.9 | $70.4 |
- Q3 revenue increased 20.2%; nine-month revenue increased 14.8%. Analytics was a major growth driver: Q3 revenue rose 53.9% to $82.7 million, including $19.2 million from SCIO after acquisition.
- Q3 gross margin fell 180 basis points and operating margin fell 240 basis points year over year. Management cited employee costs and wage inflation, acquisition-related costs, and weaker Healthcare margins following client contract terminations. Nine-month gross margin declined 150 basis points.
- Q3 net income declined 27.6%; management attributed the decrease mainly to higher taxes and interest expense and lower operating income. Nine-month net income decreased about 9.2%.
- Nine-month operating cash flow fell $23.6 million, with management citing increased working capital needs. Investing cash outflow was $240.4 million, including $231.9 million for acquisitions; financing cash inflow was $208.1 million, primarily reflecting borrowing.
Financial position and capital allocation
- At September 30, cash and cash equivalents were $97.6 million, short-term investments $144.9 million, and restricted cash $8.2 million. Current assets were $453.8 million versus current liabilities of $138.2 million.
- Total borrowings were $300.0 million, up from $60.0 million at December 31, 2017, primarily to fund SCIO. The company reported compliance with its credit agreement covenants. Debt maturities and interest-rate terms are detailed in the filing.
- SCIO purchase consideration was preliminarily estimated at $245.5 million, including $157.9 million of goodwill; purchase accounting remained subject to the measurement period. Goodwill rose to $357.5 million and net intangible assets to $114.8 million.
- The company repurchased approximately $30.0 million of shares during the first nine months. It expected 2018 capital expenditures of $35–$40 million, having spent $30.1 million through September.
Outlook, commentary, and risks
- The filing provides no specific revenue or earnings guidance. Management expects to fund routine acquisitions, capital expenditures, and working capital primarily with operating cash flow, while noting significant acquisition-led growth could require additional financing.
- On October 4, 2018, after quarter-end, the company issued $150 million of 3.50% convertible senior notes due 2024 and used the proceeds to repay part of its revolving borrowings.
- Management highlighted client and industry concentration, competition and pricing pressure, hiring and retention, acquisition integration, international operations, currency movements, cybersecurity and data protection, and the ability to service debt as risks. The top ten clients accounted for 36.7% of Q3 revenue.
- Indian tax authorities disputed transfer-pricing and permanent-establishment matters with aggregate demands of $16.4 million. The company had paid or secured $7.9 million and had not accrued a liability, stating it believed its position would be sustained. A $2.4 million settlement of a putative California class action was accrued, subject to final court approval.
- The effective tax rate was 27.3% in Q3 versus 11.8% a year earlier, primarily reflecting lower excess tax benefits from stock awards in the comparative quarter. The company continued to refine its accounting for the U.S. tax reform transition tax.
Important facts for investors to verify
- Whether SCIO integration and the acquired business’s growth support returns on the purchase price and goodwill.
- Whether margin pressure—especially in Healthcare—stabilizes, and how wage inflation and new-client ramp costs affect profitability.
- Whether working-capital needs and collections improve enough to recover operating cash flow.
- Debt reduction following the convertible-note issuance, future interest costs, and continued covenant compliance.
- Developments in the Indian tax disputes, the California settlement approval, and remaining Tax Cuts and Jobs Act accounting estimates.
- Customer concentration, currency-hedging effects, and the company’s execution against its stated 2018 capital expenditure range.