EXLS

ExlService Holdings, Inc. - 10-Q Summary (Period Ended Sep 30, 2007)

Business Context and Reporting Period

This is a Quarterly Report (Form 10-Q) for ExlService Holdings, Inc., a provider of offshore business process outsourcing (BPO), research and analytics, and advisory services. The reporting period covers the three and nine months ended September 30, 2007. The company operates primarily in the United States, United Kingdom, and India. The results for the nine months ended September 30, 2007, are not fully comparable to the prior year due to the acquisition of Inductis on July 1, 2006.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 30.7% for the quarter and 57.1% for the nine-month period compared to the prior year. Growth was driven by new client acquisitions, volume increases from existing clients, and the inclusion of Inductis results.
• Profitability: Net income to common stockholders increased 50.7% for the quarter and 130.4% for the nine-month period. This was significantly aided by a foreign exchange gain of $2.3 million for the quarter and $5.1 million for the nine months, compared to minimal gains or losses in the prior year.
• Expense Increases: Cost of revenues increased 38.9% (quarter) and 61.8% (nine months), primarily due to higher headcount, salary levels, and facility costs. SG&A expenses rose 28.4% (quarter) and 62.9% (nine months) due to hiring in the U.S. and U.K. and increased professional fees.
• Tax Provision: The effective tax rate increased to 21.5% for the quarter and 15.2% for the nine months, compared to a tax benefit in the prior year periods, due to changes in the geographic distribution of income and foreign exchange impacts.

Outlook, Risks, and Contingencies

• Client Concentration Risk: The company relies heavily on a limited number of clients. The two largest clients (Norwich Union and Centrica plc) accounted for 52.2% of revenues in the quarter and 52.6% for the nine months.
• Transfer Pricing Disputes: The company is involved in disputes with Indian tax authorities regarding transfer pricing and permanent establishment status. Three assessment orders demand additional taxes totaling approximately $10.2 million. The company has paid $4.3 million in deposits and believes the probability of loss is remote, but these disputes remain unresolved.
• Foreign Exchange Risk: A significant portion of revenues is in U.S. dollars and U.K. pounds, while expenses are largely in Indian rupees. The company uses forward contracts to hedge, but fluctuations remain a risk.
• Internal Control Deficiencies: Management concluded that disclosure controls and procedures were not effective as of September 30, 2007. Issues included insufficient staffing, lack of automation, and complexity in integrating Inductis. Remediation plans are underway.
• Capital Expenditures: The company expects to incur $11.0 million to $15.0 million in capital expenditures in 2007 to expand facilities in India and the Philippines.

Investor Verification Checklist

• Verify the status and potential financial impact of the ongoing Indian tax authority disputes (approx. $10.2 million in assessed taxes).
• Monitor the effectiveness of remediation efforts regarding the identified material weaknesses in internal controls over financial reporting.
• Assess the stability of the top two clients (Norwich Union and Centrica), which represent over 50% of revenue, and the potential impact of Norwich Union's "Transfer Option" on future revenue.
• Review the sustainability of foreign exchange gains, which significantly boosted net income in the current period.
• Confirm the timeline and cost of the new facility in the Philippines and the Noida, India expansion.