ExlService Holdings, Inc. — Q1 2017 Form 10-Q
Business context and reporting period
Unaudited results cover the three months ended March 31, 2017, compared with the three months ended March 31, 2016. ExlService provides business process management (BPM), operations management and analytics services, principally to clients in the U.S. and U.K. Unless noted otherwise, figures below are in U.S. dollars and millions.
Financial results and liquidity
| Metric | Q1 2017 | Q1 2016 / comparison |
|---|---|---|
| Revenue | $183.0 | $167.0; up 9.6% |
| Gross profit / margin | $62.9 / 34.4% | $58.7 / 35.1% |
| Operating income / margin | $15.9 / 8.7% | $16.5 / 9.8% |
| Net income / diluted EPS | $16.8 / $0.48 | $13.8 / $0.40 |
| Cash from operations | $7.1 | $(10.4) |
- Analytics revenue increased 25.8% to $49.0 million; Insurance rose 15.8% to $55.9 million and Healthcare rose 15.5% to $18.9 million. All Other revenue fell 18.8% to $21.1 million; TT&L declined 2.9% to $17.0 million.
- Gross margin fell 70 basis points. Management cited employee costs and wage inflation, lower margins from 2016 analytics acquisitions, and migration costs and reimbursable travel in Finance and Accounting. SG&A rose 10.3% to $37.6 million.
- Net income increased despite lower operating income, primarily reflecting $2.3 million lower income tax expense and a $1.1 million increase in foreign-exchange gains. Q1 2017 effective tax rate was 17.5%, versus 29.9%; it included a $2.057 million discrete tax benefit associated with adoption of share-based compensation guidance.
- Operating cash flow improved by $17.5 million year over year, although working-capital movements remained significant. Investing cash outflow was $117.1 million, mainly reflecting short-term investment purchases; capital expenditures were $10.1 million. Financing cash outflow was $11.8 million, including $11.9 million of treasury-stock purchases and related activity.
- At March 31, cash and cash equivalents were $91.7 million and short-term investments were $126.5 million. Management reported combined cash, cash equivalents and short-term investments of $218.2 million, including $176.5 million held by foreign subsidiaries. Current assets were $383.5 million and current liabilities $111.0 million.
- Debt outstanding was $45.0 million under a $100 million revolving facility, of which $10.0 million was classified as current. The facility matures in October 2019; the company reported covenant compliance. Capital leases were immaterial relative to borrowings.
Material changes, outlook and risks
- Revenue growth included acquired revenue: 2016 acquisitions contributed $6.4 million to Analytics growth, and Liss contributed $1.0 million to Insurance growth. Management also attributed growth to new and existing client business.
- Management expected 2017 capital expenditures of $30–$35 million to support facilities, technology and infrastructure. It anticipated relying on operating cash flow for smaller acquisitions, capex and working capital, while significant acquisition-led growth could require additional financing. No revenue or earnings guidance was provided.
- Management expected Analytics revenue to grow as offerings and the client base expand, organically and through acquisitions. It noted that transaction- and outcome-based pricing and clients’ multi-vendor strategies can pressure revenue and gross margins; wage inflation, hiring and retention, and long sales cycles are also relevant operating risks.
- The company stated it intends to indefinitely reinvest foreign-subsidiary earnings and does not plan to repatriate those funds; repatriation could incur taxes. Foreign exchange exposure is managed partly through forward contracts and cash-flow hedges. Management reported no material change in market-risk exposure during the quarter.
- Indian tax disputes involve transfer-pricing and permanent-establishment assessments totaling $17.9 million at March 31, 2017. The company had paid or secured $8.5 million and, based on its advisers’ assessment, recorded no provision, describing the likelihood of ultimate liability as remote. Further assessments may arise.
- The February 2017 repurchase authorization permits up to $100 million of purchases over fiscal 2017–2019, with up to $40 million authorized for each of 2017, 2018 and 2019. The company repurchased approximately $9.0 million under the programs in Q1, in addition to shares acquired for employee tax withholding.
- New revenue-recognition guidance was expected to take effect for the company in Q1 2018. Management was evaluating its impact and expected changes to the treatment of variable consideration and certain contract costs; the ultimate impact was not yet determined.
Most important facts for investors to verify
- Whether the revenue gains—especially in Analytics—continue after accounting for acquired revenue, and whether margin pressure persists.
- Whether operating cash flow remains positive as receivables, accrued employee costs and other working-capital balances fluctuate; distinguish cash from short-term investments and foreign-held funds.
- The effective tax rate’s sustainability, including the discrete share-based compensation tax benefit and the geographic mix of earnings.
- Developments in the Indian tax disputes, including any new assessments, deposits or changes to management’s no-accrual position.
- Capital spending, repurchases and acquisition funding needs relative to cash generation, debt and credit-facility covenants.
- The eventual effect and transition method for the new revenue-recognition standard on reported revenue and contract costs.