ExlService Holdings, Inc. — Q1 2014 Form 10-Q
Business context and period: Unaudited results for the three months ended March 31, 2014, compared with Q1 2013. ExlService provides business process solutions, including outsourcing services and transformation services, with operations across the U.S., Europe and Asia. Amounts below are in U.S. dollars; financial statement figures are in millions unless stated otherwise.
Financial performance and position
| Metric | Q1 2014 | Q1 2013 / comparison |
|---|---|---|
| Revenue | $121.8 | $116.0; up 5.0% |
| Gross profit / margin | $46.9 / 38.5% | $43.1 / 37.1% |
| Operating income / margin | $15.5 / 12.7% | $12.1 / 10.4% |
| Net income / margin | $11.1 / 9.2% | $9.8 / 8.4% |
| Diluted EPS | $0.33 | $0.29 |
| Cash from operating activities | $5.0 | $6.6 |
| Capital expenditures | $10.7 | $6.6 |
- Outsourcing revenue grew 2.6% to $100.1 million; transformation revenue rose 17.7% to $21.7 million. Transformation growth was primarily attributed to decision analytics.
- Revenue growth reflected $8.7 million of net volume gains from existing and new clients, partly offset by currency effects and $2.5 million of Travelers-related reimbursements recorded as a revenue reduction.
- Gross margin improved mainly due to weaker currencies against the U.S. dollar, partly offset by lower transformation-services utilization and Travelers-related costs. Operating income increased 27.9%.
- Q1 operating cash flow declined despite higher net income, mainly due to working-capital needs, including lower accrued employee costs and increases in receivables and other current assets.
- At March 31, 2014, cash and cash equivalents were $143.7 million and short-term investments were $7.2 million. The company reported $150.9 million combined cash and short-term investments, including $76.6 million held by foreign subsidiaries. Current assets were $257.9 million and current liabilities $63.0 million.
- Total liabilities were $83.3 million. Capital lease obligations totaled $2.3 million; there were no borrowings under the $15 million revolving credit facility. The filing reports no off-balance-sheet arrangements.
Material changes, outlook and risks
- Travelers termination: Following Travelers’ November 2013 termination notice, the company estimated a $12–$20 million reduction in 2014 revenue from services transitioning away. Additional reimbursements and internal disentanglement costs remained unestimable at filing time; transition services were expected to increase expenses.
- Investment plans: Management expected $15–$20 million of capital expenditures during the remainder of 2014, primarily for facilities, technology and infrastructure. Q1 capital spending was $10.7 million.
- Tax rate: The effective tax rate rose to 28.6% from 23.5%, primarily because Q1 2013 included one-time benefits from a retroactive extension of a Philippine tax holiday.
- Foreign exchange: The company reported a $0.8 million foreign-exchange loss versus $0.05 million in Q1 2013 and uses foreign-currency derivatives to hedge exposures, particularly to the Indian rupee, pound sterling and Philippine peso. Management reported no material change in market-risk exposure during the quarter.
- Tax disputes: Indian tax authorities’ transfer-pricing and permanent-establishment demands totaled $18.75 million at March 31, 2014. The company had paid or secured $14.39 million and had not accrued a liability, stating its advisers viewed the probability of crystallization as remote. Further assessments remain possible.
- Other risks highlighted include customer and industry concentration, the ability to replace Travelers business and redeploy resources, competition and pricing pressure, hiring and retention, international operations, data security, regulatory changes and potential loss of government incentives. The top ten clients generated 54.2% of Q1 revenue, down from 59.7%; no single client exceeded 10%.
- No specific full-year revenue or earnings guidance was provided in the supplied filing text. Management cautioned that interim results are not necessarily indicative of full-year performance.
Important facts for investors to verify
- Progress and realized revenue, reimbursement and transition-cost impacts from the Travelers termination versus the stated 2014 estimate.
- Whether operating cash flow improves as working-capital outflows normalize, given Q1 operating cash flow of $5.0 million and capital expenditures of $10.7 million.
- Execution of planned capital spending and its effect on capacity, revenue growth and margins.
- Developments in Indian tax disputes, including additional assessments, cash deposits or changes to the company’s no-accrual assessment.
- Foreign-exchange movements, hedge results and their effects on revenue, margins and reported earnings.
- Customer concentration and the pace at which new-client and transformation-services growth can offset Travelers-related business losses.