ExlService Holdings, Inc. — Q3 2015 Form 10-Q
Business context and period: Unaudited results for the quarter and nine months ended September 30, 2015, compared with the same 2014 periods. ExlService provides business-process solutions through Operations Management and Analytics and Business Transformation. The March 2015 RPM acquisition contributed to the latter segment.
Financial performance
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $163.5m | $122.5m | $462.6m | $364.0m |
| Gross profit / margin | $60.3m / 36.9% | $37.5m / 30.6% | $165.8m / 35.8% | $122.8m / 33.7% |
| Operating income / margin | $20.7m / 12.7% | $5.4m / 4.4% | $49.5m / 10.7% | $27.0m / 7.4% |
| Net income / margin | $15.2m / 9.2% | $6.1m / 5.0% | $36.8m / 8.0% | $25.0m / 6.9% |
| Diluted EPS | $0.44 | $0.18 | $1.08 | $0.74 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $54.6m | $44.3m |
Liquidity and debt at September 30, 2015: Cash and cash equivalents were $90.7m and short-term investments were $93.2m, or $183.8m combined. Total borrowings were $70.0m ($10.0m current and $60.0m long-term), under a $100m revolving facility maturing in 2019. Current assets were $312.3m and current liabilities $93.3m. Cash was $85.8m lower than at year-end 2014.
Cash flows, nine months: Investing activities used $145.9m, including $44.3m net cash for RPM and an $80.5m net increase in short-term investments; capital expenditures were $21.1m. Financing activities provided $9.5m, including $20m net borrowings, partly offset by $13.0m of treasury-stock purchases. The company expects $2m–$5m of additional capital expenditures in the remainder of 2015.
Material changes and drivers
- Revenue rose 33.5% in Q3 and 27.1% for the nine-month period. Management attributed growth to client volume, acquisitions, and expansion in analytics; Q3 Analytics and Business Transformation revenue increased 58.2%, while Operations Management increased 25.0%.
- Prior-period comparisons include Travelers disentanglement-cost reimbursements that reduced revenue by $9.6m in Q3 2014 and $17.8m for the first nine months of 2014. No such reimbursements were incurred in 2015, and none are expected going forward.
- RPM contributed $11.6m of Q3 revenue and $23.1m for the nine months since its March 20 acquisition. The preliminary purchase-price allocation included $33.2m goodwill; valuation remained incomplete at quarter-end. Contingent consideration had a $4.1m fair value, with up to $23m potentially payable based on 2015–2016 performance.
- Operating margins improved as revenue growth and lower SG&A and depreciation/amortization as a share of sales outweighed acquisition-related and other cost increases. Acquisition-related intangible amortization increased.
- Effective tax rate rose to 33.3% in Q3 and 34.4% year to date, from 14.2% and 15.3%, respectively. Drivers included expired tax holidays, prior-year tax items, and differences in U.S. income mix. The company recorded approximately $2.4m of additional tax expense for prior-year errors it concluded were not material to those periods.
Outlook, risks, and unusual items
- Management expects continued investment in facilities and technology and says it may need additional financing if acquisition-led growth is significant. It does not intend to repatriate overseas funds, which it considers permanently reinvested; repatriation would incur taxes.
- Key business risks include client and industry concentration, client retention, pricing pressure and multi-vendor arrangements, hiring and retention, competition, technology or telecommunications disruption, international political and economic conditions, foreign exchange, acquisition integration, data confidentiality, and changes to governmental incentives.
- Indian tax authorities disputed transfer-pricing and permanent-establishment matters totaling $19.3m as of September 30, 2015. The company had paid or provided bank guarantees for $14.7m, had not accrued a loss, and said it considered ultimate liability remote; further assessments remain possible.
- Foreign-currency exposure is managed partly with forward contracts, principally involving the Indian rupee, U.K. pound, and Philippine peso. Nine-month other comprehensive loss was $10.7m, mainly reflecting currency translation and hedge effects.
- A 2015 change in estimated useful lives of certain fixed assets reduced depreciation by $1.4m and increased nine-month net income by $0.8m, or $0.02 per basic and diluted share.
- Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter. RPM was excluded from the internal-control assessment.
Most important facts for investors to verify
- How much reported growth reflects organic expansion versus acquisitions and the absence of Travelers reimbursements in the comparison period.
- Whether the RPM acquisition achieves its performance goals and how final purchase accounting affects goodwill, amortization, and earnings.
- Whether stronger margins and cash generation persist as acquisition costs, wage increases, and capital needs evolve.
- The effect of higher effective taxes, tax-holiday expirations, and unresolved Indian tax matters on future cash taxes and earnings.
- Liquidity available for operations and acquisitions, considering cash held overseas, borrowings, debt covenants, planned investment, and share repurchases.