ExlService Holdings, Inc. — Q2 2012 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2012; unaudited. ExlService provides outsourcing and transformation services, primarily to clients in the United States and United Kingdom. Comparisons are with the corresponding 2011 periods. Dollar amounts below are in millions unless noted.
Financial performance
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Revenue | $108.0 | $85.0 | $212.6 | $157.9 |
| Gross profit / margin | $42.0 / 38.9% | $33.0 / 38.8% | $79.9 / 37.6% | $61.7 / 39.1% |
| Operating income / margin | $14.4 / 13.3% | $9.4 / 11.1% | $24.8 / 11.7% | $16.9 / 10.7% |
| Net income / margin | $9.1 / 8.4% | $8.5 / 10.0% | $18.0 / 8.5% | $16.8 / 10.7% |
| Diluted EPS | $0.27 | $0.27 | $0.55 | $0.54 |
| Operating cash flow | Not presented by quarter | $19.5 | $26.8 |
Liquidity, debt and cash flow
- At June 30, cash and cash equivalents were $94.5 million, with $6.5 million of short-term investments; total cash and investments were approximately $101.0 million. Current assets were $184.0 million and current liabilities $61.1 million.
- No borrowings were outstanding under the revolving credit facility. Availability had been reduced from $50 million to $15 million in June 2012, with potential to increase subject to conditions. Capital lease obligations totaled $5.0 million; the filing reports no off-balance-sheet arrangements.
- Six-month operating cash flow fell to $19.5 million from $26.8 million, mainly as working-capital use increased, including lower accrued employee costs and higher prepaid and other current assets. Days’ sales outstanding rose to 51 from 49 at year-end 2011.
- Six-month capital expenditures were $13.2 million. Management expected another $10–$15 million of capital spending in the remainder of 2012. Cash increased by $12.1 million to $94.5 million during the six months.
Changes and management commentary
- Revenue rose 27.1% in Q2 and 34.6% for the six months. Management attributed most of the outsourcing-services increase to the OPI and Trumbull acquisitions, alongside client-volume gains; currency translation partly offset growth. Transformation-services revenue increased more modestly.
- Operating income grew 53.0% in Q2 and 46.7% year to date, with operating margins improving as SG&A declined as a share of revenue. Year-to-date gross margin nevertheless fell 1.5 percentage points, reflecting acquisition effects and a $2.2 million one-time client payment included in 2011 results.
- Net income growth lagged operating-income growth because foreign exchange results turned unfavorable and income-tax expense increased. Q2 foreign-exchange loss was $2.1 million versus a $1.8 million gain a year earlier; six-month results were a $1.0 million loss versus a $3.5 million gain.
- The six-month effective tax rate rose to 27.0% from 21.1%, primarily because of the prior-year release of a $2.0 million deferred-tax valuation allowance and the expiry of Indian tax holidays. Management noted that tax expense may remain higher; extension of a Philippine tax holiday was pending.
- Total comprehensive income was $11.8 million for the six months, versus $18.1 million in 2011. Q2 comprehensive loss was $9.8 million, despite positive net income, principally reflecting foreign-currency translation and cash-flow hedge losses. Accumulated other comprehensive loss was $46.1 million at June 30.
Outlook, risks and contingencies
- Management expected revenue to grow through expanded services and clients, organically and through acquisitions; the filing gives no specific revenue or earnings guidance. It anticipated additional capital spending as described above.
- Key operating risks include dependence on a limited number of clients and industries, client termination rights, competition and pricing pressure, hiring and retention, growth and acquisition integration, offshore-outsourcing sentiment, technology and data-security disruptions, and foreign-exchange movements. The three largest clients generated 26.1% of Q2 revenue; Travelers contributed 10.3% and may terminate its agreement on 60 days’ notice.
- The company hedges substantial currency exposure, but reported outstanding foreign-exchange contracts and significant derivative liabilities. Approximately $9.1 million of net derivative losses in accumulated other comprehensive income could be reclassified into earnings within 12 months.
- Indian tax authorities had issued assessments totaling $18.4 million, including interest; $12.2 million had been deposited and $2.4 million secured by bank guarantees. The company considered loss remote and recorded no provision, but similar assessments could follow. Unrecognized tax benefits were $5.5 million.
- Other commitments included $28.6 million of operating leases, $5.8 million of minimum capital-lease payments and $2.3 million of fixed-asset purchase obligations. The company also noted possible repayment, penalties or fines if certain Indian export-unit incentive conditions are not met.
Important facts for investors to verify
- How much of reported growth and margin improvement is sustainable excluding acquisitions, currency movements and the prior-year one-time client payment?
- Whether client concentration, termination provisions and pricing-model changes affect renewals, revenue visibility or margins.
- Cash conversion, receivables and working-capital trends, including the increase in days’ sales outstanding.
- Exposure to Indian tax assessments and tax-holiday changes, and whether Philippine tax-holiday extensions are granted.
- Potential earnings and equity effects from currency movements, derivative losses and expected AOCI reclassifications.