ExlService Holdings, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; unaudited consolidated results compared with Q1 2018. ExlService provides business process management, operations management, consulting and analytics services. Amounts below are in U.S. dollars unless stated otherwise.
Financial performance
- Revenue: $239.6 million, up 15.8% from $207.0 million. Analytics revenue rose 52.3% to $87.0 million, including $19.1 million attributed to the SCIO acquisition and $11.3 million to client engagements. Healthcare revenue declined 9.8% to $20.6 million, mainly due to Health Integrated.
- Profit and margins: Gross profit was $82.3 million; gross margin improved to 34.4% from 33.3%. Operating income increased 11.3% to $16.9 million, while operating margin eased to 7.0% from 7.3%. Net income fell to $14.7 million from $23.2 million; diluted EPS was $0.42 versus $0.66. Net margin was 6.1% versus 11.2%.
- Cash flow: Operating cash flow was $8.3 million, compared with an $8.0 million use in Q1 2018. Investing activities used $37.2 million, chiefly reflecting net purchases of investments; financing provided $19.8 million, including net revolver borrowing and share repurchases. Capital expenditures were $10.9 million.
- Liquidity: Cash and cash equivalents were $86.7 million; short-term investments were $216.1 million. Together with restricted cash, cash, cash equivalents and restricted cash totaled $94.6 million. Management reported cash, cash equivalents and short-term investments of $302.7 million.
- Debt: Borrowings included $186.0 million outstanding under the revolving facility, $150.0 million principal of 3.50% convertible notes due 2024, and $1.5 million of structured payables. The company was in compliance with its credit agreement covenants at quarter-end. Interest expense rose to $3.6 million from $0.5 million.
- Other metrics: The effective tax rate was 22.1%, compared with a benefit rate of 23.7% in Q1 2018. Other income included $3.5 million of gains on sale and mark-to-market of mutual funds. Total assets were $1.18 billion and total liabilities $551.7 million at March 31, 2019.
Material changes versus Q1 2018
- Revenue growth was led by Analytics and partly reflected SCIO, acquired in July 2018. Analytics reached 36.3% of revenue, up from 27.6%.
- Gross margin improved 110 basis points overall, but Healthcare gross margin fell 700 basis points, which management attributed to Health Integrated, lower revenue from existing clients and contract terminations.
- Net income decreased primarily because income tax expense increased by $8.7 million and interest expense by $3.1 million; higher operating income, other income and foreign-exchange gains partly offset those effects.
- Accounts receivable increased to $176.9 million from $164.8 million. Management cited working-capital uses, including receivables and accrued employee costs, as factors limiting operating cash flow.
Outlook, risks and unusual items
- No full-year revenue or earnings guidance is provided in the filing. Management expects 2019 capital expenditures of $35 million to $40 million for growth, facilities, technology and infrastructure.
- The company is substantially winding down Health Integrated and expects the process to be substantially complete by year-end 2019. It had recorded a provisional $1.2 million software impairment in Q1; the amount or range of future exit costs had not yet been determined. The segment had also incurred goodwill and intangible-asset impairments in 2018.
- Operating lease accounting adoption added $89.8 million of right-of-use assets and $99.4 million of operating lease liabilities at March 31, 2019. The adoption materially affected the balance sheet but did not materially affect income or cash flows.
- Indian tax authorities’ demands related to transfer pricing and permanent-establishment disputes totaled $17.9 million net of advance payments. The company had paid or provided bank guarantees for $8.2 million and had not accrued the disputed amount, stating it believed its position would be sustained. Additional assessments remain possible.
- Other risks include reliance on large clients (the top ten generated 38.4% of Q1 revenue), foreign-exchange exposure, acquisition integration, competition and pricing pressure, staffing, cybersecurity, debt service, and the recoverability of goodwill and intangible assets. Management said there were no material changes in market-risk exposure and no off-balance-sheet arrangements.
Important facts for investors to verify
- Whether Analytics growth and SCIO performance are recurring and support margins, rather than primarily acquisition-driven.
- Progress, remaining costs and financial effects of the Health Integrated wind-down, including any further impairment charges.
- Receivables, collections and working-capital trends, and whether operating cash flow improves alongside earnings.
- Debt repayment capacity, covenant headroom and potential dilution or cash settlement under the convertible notes.
- Developments in Indian tax disputes and the adequacy of recorded provisions and related deposits or guarantees.
- The sustainability of earnings excluding mutual-fund gains and the unusually favorable tax comparison in Q1 2018.