ExlService Holdings, Inc. — FY2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. The filing also reports fourth-quarter results; it is not a standalone Q4 filing. Amounts are U.S. dollars unless noted.
Business context
EXL provides business process management, operations management and analytics services, principally to insurance, healthcare, travel, transportation and logistics, banking and financial services, and utilities clients. It had approximately 26,000 employees. The company changed its reportable-segment presentation in 2016; prior periods were recast, with no effect on consolidated financial statements.
Financial performance and liquidity
| Metric | FY2016 | FY2015 | Change |
|---|---|---|---|
| Revenue | $686.0 million | $628.5 million | +9.1% |
| Gross profit / margin | $238.0 million / 34.7% | $225.6 million / 35.9% | Margin down 1.2 percentage points |
| Operating income / margin | $64.2 million / 9.4% | $67.3 million / 10.7% | Income down 4.6% |
| Net income / margin | $61.7 million / 9.0% | $51.6 million / 8.2% | +19.7% |
| Diluted EPS | $1.79 | $1.51 | +18.5% |
| Cash from operations | $100.3 million | $96.7 million | +$3.6 million |
Q4 2016 revenue was $177.3 million, versus $165.9 million in Q4 2015; gross profit was $61.5 million versus $59.7 million, and net income was $15.5 million versus $14.8 million.
At year-end, cash and cash equivalents were $213.2 million, short-term investments $13.5 million, and borrowings $45.0 million. Working capital was $254.6 million. Cash, cash equivalents and short-term investments less borrowings were approximately $181.6 million, excluding restricted cash. The $100 million revolving facility matures in October 2019; $10 million of borrowings was classified as current. EXL reported compliance with its financial covenants and no off-balance-sheet arrangements.
Capital expenditures were $25.9 million in 2016. Management expected 2017 capital expenditures of $35–40 million, primarily for growth, facilities and technology. Operating cash flow is expected to fund ordinary investment and working-capital needs; larger acquisitions could require additional financing.
Material changes and unusual items
- Analytics revenue rose 35.6% to $165.7 million, supported by organic growth and acquisitions; Healthcare revenue increased 24.5% to $68.7 million. “All Other” revenue fell 12.7% to $96.5 million, mainly from lower Consulting and Utilities revenue. Insurance revenue grew 3.2% to $206.3 million.
- Gross margin contracted as overall cost of revenue grew 11.2%, faster than revenue. Management cited wage and employee costs, migration costs on new client wins, and lower-margin work; Healthcare margins improved, while Insurance margins declined.
- Net income benefited from a lower effective tax rate (26.4%, versus 32.0%) and higher non-operating income. Other income included an $8.1 million gain on mutual-fund sales and a $4.1 million reversal of an RPM acquisition earn-out liability after performance targets were not achieved. Foreign-exchange gain was $5.6 million, versus $2.8 million.
- EXL acquired Liss, IQR and Datasource in 2016 for an aggregate $30.5 million of stated purchase consideration; acquired businesses contributed $6.9 million of revenue from their respective closing dates through year-end. Datasource purchase accounting remained preliminary at year-end.
- The company repurchased 364,056 shares for approximately $17.4 million under its buyback program. It does not anticipate cash dividends in the foreseeable future.
Outlook, risks and contingencies
The filing provides no specific revenue or earnings guidance. Management described continued investment in analytics, BPaaS, automation, technology, talent and global delivery, and expects Analytics revenue to grow as offerings and client base expand. The principal risks include client concentration (top ten clients generated 40.1% of revenue), employee attrition and wage inflation, pricing and competition, execution and integration of acquisitions, foreign-exchange exposure, and cyber, privacy and service-disruption risks. More than 80% of revenue came from the U.S.; significant operating costs are denominated in Indian rupees and Philippine pesos.
EXL disclosed Indian tax disputes involving transfer pricing and permanent-establishment issues. Tax authorities demanded $18.0 million in aggregate at December 31, 2016; the company had paid or provided bank guarantees for $8.6 million. Management considered ultimate liability remote and recorded no provision. The filing also warns that expiring tax holidays could increase the effective tax rate. Auditors issued unqualified opinions on the financial statements and internal controls; acquired companies’ internal controls were excluded from the 2016 assessment.
Investor facts to verify
- Whether organic growth and acquired revenue contributions support continued growth, particularly in Analytics, and whether declining “All Other” revenue stabilizes.
- Whether margins recover after the 2016 decline and how wage inflation, attrition, client migrations and alternative pricing models affect profitability.
- Cash conversion and receivables: accounts receivable rose to $113.1 million from $92.7 million, including $34.8 million unbilled.
- Integration and final purchase accounting for Liss, IQR and Datasource, including the carrying value and impairment risk of goodwill and intangibles.
- Progress and potential financial impact of Indian tax disputes, tax-holiday expirations, and the company’s ability to retain tax incentives.
- Execution of planned 2017 capital spending, future borrowing needs, and the impact of foreign-exchange movements and hedges.