EXLS

ExlService Holdings, Inc. - Q1 2011 Filing Summary

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2011. ExlService Holdings, Inc. is a leading provider of outsourcing and transformation services, primarily serving clients in the United States and the United Kingdom within the insurance, utilities, banking, and travel sectors. The company operates through two segments: Outsourcing Services and Transformation Services.

Key Financial Metrics

Margins: Gross margin decreased from 42.2% in Q1 2010 to 39.3% in Q1 2011. Operating margin decreased from 11.9% to 10.3%. Net income margin increased from 10.3% to 11.5%.

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 33.8% year-over-year, driven by $7.7 million in revenue from recent acquisitions (GTSC and PDMA) and $7.2 million in net volume increases from existing and new clients.
• Cost Structure: Cost of revenues increased 40.4%, outpacing revenue growth due to higher employee-related costs ($8.9 million increase) and facility/technology expenses ($3.0 million increase) associated with expansion and acquisitions.
• Tax Provision: The effective tax rate dropped significantly from 25.0% to 11.8%. This was primarily due to the release of a $1.961 million valuation allowance on deferred tax assets related to Indian operations under a tax holiday period.
• Cash Flow: Operating cash flow turned positive at $7.8 million, compared to a negative $0.9 million in the prior year, largely due to improved working capital management and the absence of a large bank guarantee payment made in the prior year.

Guidance, Outlook, and Risks

• Acquisition Activity: On April 30, 2011, the company entered into a definitive agreement to acquire Business Process Outsourcing, Inc. (OPI) for approximately $91 million in cash.
• Capital Expenditures: The company expects to incur $15.0 million to $18.0 million in capital expenditures for the remainder of 2011 to support facility expansions in Noida, India, and internal technology improvements.
• Tax Risks: The company faces significant tax exposure in India. While the current quarter benefited from a tax holiday expiration, future tax expenses are expected to increase. Additionally, the company is involved in disputes with Indian tax authorities regarding transfer pricing and permanent establishment status, with assessment orders totaling approximately $17.8 million (though the company believes the probability of loss is remote).
• Client Concentration: The three largest clients accounted for 38.2% of total revenues in Q1 2011. Key clients include The Travelers Companies (13.8%), Centrica plc (12.8%), and American Express (11.6%).
• Market Risks: The company is exposed to foreign currency fluctuations (primarily Indian Rupee, UK Pound, and Philippine Peso) and industry trends toward multi-vendor relationships which may pressure pricing.

Investor Verification Checklist

• Tax Holiday Expiration: Verify the impact of the April 1, 2011 expiration of the Indian tax holiday on future effective tax rates and net income.
• Indian Tax Disputes: Review the status of the $17.8 million in assessment orders from Indian tax authorities and the adequacy of the company's reserves.
• Acquisition Integration: Monitor the integration and financial performance of the newly acquired OPI (announced post-period) and the previously acquired GTSC and PDMA units.
• Client Retention: Assess the renewal status of contracts with top clients, particularly Travelers (expires Dec 2013) and Centrica (expires April 2012), given the high concentration risk.
• Margin Pressure: Analyze whether the decline in gross margin (39.3%) is a temporary result of ramp-up costs or a structural shift due to competitive pricing models.