ExlService Holdings, Inc. — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. ExlService provides outsourcing and transformation services, primarily to clients in the U.S. and U.K. Financial amounts below are in U.S. dollars; “millions” applies unless stated otherwise.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Revenue | $112.6 | $100.0 | $325.3 | $258.0 |
| Gross profit / margin | $44.0 / 39.1% | $38.3 / 38.3% | $123.9 / 38.1% | $100.0 / 38.8% |
| Operating income / margin | $16.9 / 15.0% | $11.7 / 11.7% | $41.7 / 12.8% | $28.6 / 11.1% |
| Net income / margin | $11.7 / 10.4% | $8.4 / 8.4% | $29.7 / 9.1% | $25.2 / 9.8% |
| Diluted EPS | $0.35 | $0.27 | $0.90 | $0.81 |
| Operating cash flow | Not separately reported for quarter | $43.4 | $40.5 |
- Q3 revenue rose 12.6%; operating income grew 44.7% and net income 39.5%. Nine-month revenue rose 26.1%; operating income grew 45.9% and net income 17.6%.
- Outsourcing revenue was $92.0 million in Q3 and $270.6 million for nine months; transformation revenue was $20.7 million and $54.6 million, respectively.
- At September 30, cash and cash equivalents were $118.6 million and short-term investments $6.8 million. Total liabilities were $80.7 million, including $4.9 million of capital lease obligations. No borrowings were outstanding under the credit facility; its availability had been reduced from $50 million to $15 million, subject to possible increase on specified conditions.
- Nine-month capital expenditures were $17.0 million. Operating cash flow less capital expenditures was approximately $26.3 million. Days’ sales outstanding increased to 52 from 49 at year-end 2011.
Changes and drivers
- Q3 outsourcing growth reflected $2.1 million from Trumbull and $11.5 million in net volume gains, partly offset by $4.8 million of currency-related revenue reduction. Nine-month outsourcing growth included $45.9 million from OPI and Trumbull and $27.8 million of net volume gains, partly offset by $11.9 million of currency effects.
- Q3 gross margin improved year over year, while nine-month gross margin declined from 38.8% to 38.1%. Management attributed the nine-month pressure partly to the 2011 OPI and Trumbull acquisitions and a $2.2 million one-time client payment in 2011.
- Operating margins improved in both comparisons, mainly as SG&A declined as a share of revenue. Nine-month net margin fell, in part because of lower foreign-exchange results and a higher effective tax rate.
- Foreign exchange moved from a $0.5 million gain in Q3 2011 to a $1.3 million loss in Q3 2012; for nine months, a $3.9 million gain became a $2.4 million loss. The nine-month effective tax rate rose to 27.0% from 25.5%.
Outlook, risks and unusual items
- Management expects revenue to grow through expansion of services and clients, organically and through acquisitions, but gives no quantified revenue or earnings guidance in the provided filing text. It expected $3–5 million of capital expenditures for the remainder of 2012.
- On October 12, 2012, after quarter-end, the company acquired Landacorp for $37.5 million in cash, subject to working-capital adjustments.
- Client concentration remains material: the three largest clients generated 25.8% of Q3 revenue and 26.2% for the first nine months. Travelers contributed 9.9% and 10.2%, respectively, and could terminate its agreement or work orders on 60 days’ notice; the disclosed work orders expire in December 2013.
- Management cited risks from foreign-exchange movements, client concentration and termination rights, pricing pressure and multi-vendor contracting, hiring and retention, acquisitions and integration, offshore-outsourcing sentiment, technology and data security, and changes to government tax incentives.
- Indian tax authorities have assessed $19.4 million in transfer-pricing and related tax demands. The company had deposited $12.8 million and provided $2.5 million in bank guarantees; management considered the likelihood of loss remote and recorded no accrual. The filing notes potential similar assessments for later years.
- Philippine tax-holiday extensions were pending; denial or changes in applicable rules could increase tax expense. Total contractual cash obligations were $40.9 million, excluding $3.1 million of uncertain tax positions whose payment timing and amount were not reliably estimable.
Important facts for investors to verify
- How much of reported growth is organic versus acquisition-related, and whether the improved operating margin can be sustained.
- Client concentration, contract termination provisions, and Travelers’ exposure as its disclosed work orders approach expiration.
- Foreign-exchange sensitivity, hedge positions, and the impact of the $3.3 million of net derivative losses expected to be reclassified into earnings within 12 months.
- Outcome and possible cash impact of Indian tax disputes, and status of Philippine tax-holiday extensions.
- Landacorp’s integration, acquisition economics, and post-acquisition liquidity, noting reported cash and investments are before the $37.5 million purchase.