ExlService Holdings, Inc. — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015. Unaudited consolidated results; financial amounts below are in millions of dollars unless stated otherwise. ExlService provides business process solutions through Operations Management and Analytics and Business Transformation.
Financial performance
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Revenue | $155.6 | $119.7 | $299.1 | $241.5 |
| Gross profit / margin | $55.1 / 35.4% | $38.5 / 32.1% | $105.5 / 35.3% | $85.4 / 35.3% |
| Operating income / margin | $15.2 / 9.8% | $6.1 / 5.1% | $28.7 / 9.6% | $21.6 / 8.9% |
| Net income / margin | $12.1 / 7.8% | $7.8 / 6.5% | $21.6 / 7.2% | $18.9 / 7.8% |
| Diluted EPS | $0.35 | $0.23 | $0.63 | $0.56 |
- Q2 revenue increased 30.0% year over year; six-month revenue increased 23.8%. Analytics and Business Transformation revenue grew 69.2% in Q2 and 60.9% for the half; Operations Management grew 19.4% and 14.8%, respectively.
- Q2 net income rose 55.5%; first-half net income rose 14.4%. First-half net margin declined from 7.8% to 7.2%, mainly reflecting higher income taxes.
- Cash flow: First-half operating cash flow was $27.2, compared with $27.8 in 2014. Investing used $124.5, principally including the RPM acquisition and increased purchases of short-term investments. Financing provided $16.8. Cash and equivalents ended at $94.7, down from $176.5 at year-end 2014.
- Liquidity and debt: Cash plus short-term investments totaled $172.5 at June 30; current assets were $301.6 and current liabilities $94.9. Total borrowings were $70.0, including $10.0 classified as short term. The $100.0 revolving facility matures in 2019; the reported effective rate was 1.56% for the quarter and half-year.
Material changes and drivers
- Growth reflected acquisitions and organic client volume. RPM, acquired March 20, contributed $10.3 of Q2 revenue and $11.5 for the six-month period; Overland contributed $17.4 in Q2 and $34.3 for the half to Operations Management. The filing also attributes part of growth to Blue Slate.
- Q2 gross margin improved, while first-half gross margin was unchanged. Management cited higher revenue and favorable currency effects, alongside acquisition-related and other higher delivery costs. Operating margins improved in both periods as operating expenses grew more slowly than revenue.
- Prior-year revenue included Travelers disentanglement-cost reimbursements recorded as revenue reductions: $5.7 in Q2 and $8.2 for the first half. No such reimbursements occurred in 2015, and management expects none going forward. Travelers revenue itself also declined year over year.
- The effective tax rate was 31.4% in Q2 2015 versus negative 13.8% in Q2 2014, and 35.2% for the first half versus 15.7%. First-half 2015 tax expense included about $1.8 of prior-year tax errors, which management concluded were not material to the affected periods; expiration of tax holidays in India and the Philippines also contributed. The 2014 comparison included a $2.2 reversal of an unrecognized tax benefit.
Outlook, risks and unusual items
- No revenue or earnings guidance is provided in the supplied filing text. Management estimated remaining-2015 capital expenditures of $8–$12, in addition to $14.4 spent in the first half.
- Management expects to retain and reinvest overseas earnings; $38.7 of cash and equivalents was held by foreign subsidiaries. Repatriation would incur applicable taxes.
- RPM purchase accounting remained preliminary. Consideration included cash, restricted shares and contingent earn-out consideration with an estimated fair value of $2.8; sellers could earn up to $23.0 based on 2015–2016 performance. RPM goodwill recorded was $30.8, subject to valuation finalization.
- Indian tax disputes involved aggregate demands of $19.8 at June 30, relating to transfer pricing and permanent-establishment matters. The company had paid or provided bank guarantees for $15.1 and recorded no accrual, stating that ultimate liability was considered remote based on advisers’ views. Additional assessments remain possible.
- Key risks include client and industry concentration, client losses, pricing and multi-vendor pressures, hiring and retention, acquisition integration, foreign-exchange exposure, offshore-outsourcing sentiment, regulatory or tax changes, technology disruption, and protection of client data. The top ten clients represented 43.9% of Q2 revenue; no single client exceeded 10%.
- A change in estimated useful lives of certain fixed assets reduced depreciation by $0.5 in Q2 and $0.9 for the half, increasing net income by $0.3 and $0.6, respectively. The filing reports no material change in market-risk exposure and no off-balance-sheet arrangements.
Important facts for investors to verify
- How much of reported growth and margin improvement is sustainable organically versus attributable to acquisitions, currency movements, and the absence of Travelers reimbursements?
- Whether working-capital demands, including the increase in receivables, affect operating cash conversion as the business grows.
- The final RPM purchase-price allocation, earn-out outcomes, integration costs, and acquired-business profitability; the filing does not provide RPM net earnings.
- Developments in Indian tax disputes and unrecognized tax benefits, including potential additional assessments and related cash deposits or guarantees.
- Whether the higher effective tax rate persists after the one-time tax items and expired tax holidays described in the filing.
- Compliance with credit-facility covenants and the company’s liquidity and financing needs alongside acquisition, capital-spending, and share-repurchase plans.