Business context and reporting period
ExlService Holdings, Inc. (EXL) filed this Form 10-K for the fiscal year ended December 31, 2017. EXL provides business process management, operations management, consulting and analytics services, primarily to clients in insurance, healthcare, travel and logistics, banking and financial services, and utilities. It reported approximately 27,800 employees. The filing also provides unaudited fourth-quarter results.
Financial performance and liquidity
| Metric | FY 2017 | FY 2016 |
|---|---|---|
| Revenue | $762.3 million | $686.0 million |
| Gross profit / margin | $266.7 million / 35.0% | $238.0 million / 34.7% |
| Operating income / margin | $72.2 million / 9.5% | $64.2 million / 9.4% |
| Net income / margin | $48.9 million / 6.4% | $61.7 million / 9.0% |
| Diluted EPS | $1.39 | $1.79 |
| Cash from operations | $113.1 million | $100.3 million |
- Revenue rose 11.1%; operating income increased 12.5%, while net income declined 20.8%.
- Cash and cash equivalents were $86.8 million at year-end; short-term investments were $178.5 million, bringing cash, cash equivalents and short-term investments to $265.3 million, versus $226.6 million in 2016. Working capital was $308.6 million.
- Net cash used in investing was $222.7 million, including net purchases of short-term investments, $35.2 million of capital expenditures, and $23.3 million paid for the Health Integrated acquisition. Net cash used in financing was $20.5 million.
- Year-end borrowings were $60.0 million under the new revolving credit facility, plus approximately $0.7 million of structured payables. The filing’s selected financial data reports borrowings of $60.7 million. The $200 million facility matures in November 2022; EXL was in compliance with its covenants at year-end.
Material changes versus the prior comparable period
- Analytics revenue increased 26.7% to $209.9 million; Insurance revenue rose 13.8% to $234.8 million. All Other revenue fell 13.9% to $83.1 million, primarily reflecting lower Consulting and Utilities revenue.
- Gross margin expanded by 30 basis points, but segment trends varied: Insurance improved 300 basis points and TT&L 210 basis points; Analytics declined 110 basis points and All Other 490 basis points.
- Income tax expense rose to $36.1 million from $22.2 million. The 42.5% effective tax rate included a provisional $29.2 million charge related to the Tax Reform Act, partly offset by a $9.8 million excess tax benefit on stock awards and other tax items.
- Fourth-quarter revenue was $197.9 million. The quarter reported a net loss of $9.4 million and diluted loss per share of $0.27, compared with net income of $15.5 million in fourth-quarter 2016. The annual filing attributes the tax-rate increase principally to tax reform; the supplied quarterly summary does not separately quantify the quarter’s tax effects.
- EXL acquired substantially all Health Integrated assets on December 22, 2017, for preliminary consideration of $23.5 million, including estimated earn-out fair value. The acquisition contributed insignificant revenue in 2017; purchase accounting remained preliminary. EXL also invested $3.0 million in Corridor Platform.
Outlook, commentary, risks and unusual items
- No numeric revenue or earnings guidance is provided. Management expected 2018 capital expenditures of $35 million to $40 million and said it anticipates continued growth in Analytics, while describing investment in facilities, digital technology, automation and robotics.
- Management cited cost pressure from wage inflation, hiring and training, and investment in technology and infrastructure. Attrition among employees with more than 180 days’ service was 32.0%, up from 31.5% in 2016.
- Key business risks include client concentration and termination rights, intense competition and pricing pressure, employee retention, execution of complex projects and acquisitions, foreign-exchange exposure, cybersecurity and data privacy, and changes to offshore outsourcing rules or tax incentives. The top ten clients generated 38.6% of revenue; no individual client exceeded 10%.
- EXL is contesting Indian tax assessments involving transfer pricing and permanent establishment issues. Authorities’ aggregate demand, net of advance payments, was $18.1 million at year-end; EXL had paid or provided bank guarantees for $8.6 million. Management stated that potential ultimate liability was remote and recorded no provision.
- The company’s foreign subsidiaries had approximately $376.6 million of undistributed earnings. The Tax Reform Act’s transition tax was recorded provisionally, and the final tax impact could change as guidance and analysis develop.
- Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting. Health Integrated was excluded from the internal-control assessment; it represented 3.8% of total and net assets at year-end.
Important facts for investors to verify
- Review the final accounting and any subsequent adjustments for the Health Integrated acquisition, including earn-out terms, acquired intangibles and goodwill.
- Track the final Tax Reform Act measurement, effective tax rate, and the expiry of Indian and Philippine tax incentives.
- Assess the status and possible financial consequences of Indian tax disputes and related deposits or guarantees.
- Monitor Analytics and Healthcare growth against segment margins, and whether weakness in Consulting and Utilities persists.
- Reconcile reported cash with short-term investments, offshore cash availability, capital spending, buybacks and debt; assess covenant headroom under the new credit agreement.
- Consider the fourth-quarter net loss in light of annual profitability and the one-time tax charge; the filing does not provide a clear standalone quarterly reconciliation of the tax effects.