ExlService Holdings, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. ExlService provides business process management, operations management and analytics services. Unless otherwise noted, amounts are in U.S. dollars.
Financial performance
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Revenue | $207.0 million | $183.0 million | Up 13.1% |
| Gross profit / margin | $68.9 million / 33.3% | $64.0 million / 34.9% | Margin down 160 bps |
| Operating income / margin | $15.2 million / 7.3% | $17.2 million / 9.4% | Income down 12.0% |
| Net income | $23.2 million | $16.8 million | Up 38.0% |
| Diluted EPS | $0.66 | $0.48 | Up $0.18 |
| Operating cash flow | $(8.0) million | $6.0 million | Down $14.0 million |
Revenue growth was led by Insurance (+14.3%), Healthcare (+20.4%), Finance and Accounting (+14.1%), and Analytics (+16.5%). Healthcare growth included $6.4 million from the Health Integrated acquisition, partly offset by $2.5 million from terminated client contracts. The U.S. generated 82.7% of revenue and the U.K. 13.5%; the top ten clients represented 39.6% of revenue.
Net income benefited substantially from a $4.5 million income tax benefit, compared with $3.6 million of tax expense in Q1 2017. The 2018 benefit reflected a $4.8 million reduction in the provisional transition-tax estimate, the lower U.S. corporate tax rate, and excess tax benefits on stock awards. Other income included a $3.1 million gain on mutual funds.
Liquidity, debt and cash flow
- At March 31, cash and cash equivalents were $70.0 million, short-term investments $169.5 million, and restricted cash $6.5 million. Cash, cash equivalents and restricted cash totaled $76.5 million for cash-flow reporting purposes.
- Total current assets were $436.0 million and current liabilities $104.9 million. The company reported $67.0 million of debt under its $200 million revolving credit facility, with maturity in November 2022; it was in compliance with its covenants.
- Operating cash use reflected working-capital requirements, including higher advance tax and other operating assets and lower accrued employee costs and accounts payable. Capital expenditures were $12.7 million in the quarter.
- Investing cash use was $3.0 million, versus $117.1 million in Q1 2017, largely reflecting the change in net investment purchases and redemptions. Financing cash use was $6.2 million and included $13.5 million of treasury-stock purchases.
Changes, outlook and risks
- Revenue grew, but gross margin and operating margin contracted. Management attributed margin pressure to higher labor, technology and infrastructure costs, including wage inflation and costs associated with new client work. Healthcare margin fell 1,060 bps, partly due to Health Integrated and client contract terminations.
- Management expects 2018 capital expenditures of $35 million to $40 million, primarily for facilities, technology, product development, automation and infrastructure. The filing provides no specific revenue or earnings guidance.
- On April 28, 2018, the company agreed to acquire SCIOInspire Holdings for aggregate consideration of $240 million, subject to adjustments and closing conditions. It expected to fund the purchase with cash and credit-facility borrowings; closing was expected within three months.
- Indian tax disputes involved $17.7 million of aggregate demands at quarter-end; $8.7 million had been paid or supported by bank guarantees. The company had not accrued for these matters and stated it believed its positions would be sustained. A separate class action settlement of $2.4 million was accrued, subject to court approval.
- The company had not completed its accounting for certain Tax Cuts and Jobs Act effects, including the transition tax. Other disclosed risks include client concentration, wage and retention pressures, competition and pricing, acquisitions, foreign exchange, cybersecurity, and regulatory or tax developments.
- Topic 606 adoption added $454,000 to opening equity, principally for contract acquisition costs; it had no significant impact on Q1 revenue measurement or recognition. The Q1 comparison is not fully on the same accounting basis because prior-period revenue was not recast.
Important facts for investors to verify
- Whether operating-margin pressure and negative operating cash flow persist, and how working capital converts to cash in subsequent quarters.
- Whether the SCIO acquisition closes on the stated terms, its funding mix, and its effect on leverage and integration costs.
- Healthcare segment profitability following Health Integrated’s acquisition and client contract terminations.
- Final outcomes and potential cash exposure from Indian tax disputes, the provisional transition-tax accounting, and the court approval of the $2.4 million settlement.
- Client concentration and the effects of wage inflation, alternative pricing models, and foreign-exchange movements on margins.