Exlservice Holdings, Inc. quarterly report, Q1 FY2020

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Business context and reporting period

ExlService Holdings, Inc. (EXLS) filed this unaudited Form 10-Q for the quarter ended March 31, 2020. The company provides business process management and analytics services, principally to clients in the United States and United Kingdom. Effective January 1, 2020, it reorganized reporting into Insurance, Healthcare, Analytics and Emerging Business; prior segment results were recast for comparison.

Financial performance and position

Unless noted otherwise, amounts are in millions of U.S. dollars. The comparable period is the three months ended March 31, 2019.

  • Revenue: $246.0, up 2.7% from $239.6. Analytics contributed $92.4 (+6.3%), Insurance $83.7 (+3.0%), Healthcare $27.0 (+21.5%) and Emerging Business $42.8 (-12.8%).
  • Profit and margins: Gross profit was $83.3 versus $82.3; gross margin declined to 33.9% from 34.4%. Operating income rose to $27.5 from $16.9, with operating margin improving to 11.2% from 7.0%. Net income was $22.4 versus $14.7; net margin was 9.1% versus 6.1%. Diluted EPS was $0.65 versus $0.42.
  • Operating costs and other items: SG&A declined 14.2% to $43.4. No impairment or restructuring charge was recorded, compared with $1.2 in the prior-year quarter. Other income fell to $2.5 from $4.4, mainly because of lower mutual-fund returns.
  • Cash flow: Operating activities used $13.6, versus $8.3 provided. Management attributed the outflow primarily to working-capital uses, including lower accrued employee costs and higher receivables. Investing activities provided $36.0, largely reflecting investment redemptions; financing activities provided $86.7, including net borrowing. Cash, cash equivalents and restricted cash ended at $233.5.
  • Liquidity and debt: Cash and short-term investments totaled $367.4 at quarter-end. Borrowings had $349.7 of principal outstanding, including $199.0 under the revolving facility and $150.0 of 3.5% convertible notes due 2024. The company drew $100.0 on its revolver in March for precautionary liquidity and repaid it in full on April 20, 2020. It reported compliance with credit-facility covenants at March 31.
  • Other balance-sheet metrics: Total assets were $1,267.3 and total liabilities $611.4 at March 31, 2020. Operating lease liabilities totaled $111.9.

Material changes versus the prior comparable period

  • Revenue growth was modest and uneven: strong Healthcare growth and gains in Analytics and Insurance were partly offset by a decline in Emerging Business, including terminated client contracts.
  • Operating income improved substantially as lower SG&A and the absence of the prior-year impairment charge more than offset slightly lower gross margin. Management said COVID-19-related expenses reduced gross margin by 80 basis points; other factors helped limit the total year-over-year decline to 50 basis points.
  • Operating cash flow shifted from positive to negative, largely reflecting working-capital movements. The company’s precautionary revolver draw increased financing cash flow and quarter-end liquidity.
  • Other comprehensive loss was $28.2, principally from foreign-currency translation and cash-flow hedge losses; total comprehensive loss was $5.8 despite positive net income.

Outlook, commentary, risks and unusual items

  • COVID-19: Management said the pandemic had no significant impact on first-quarter results but expected it and related economic disruption to adversely affect fiscal 2020 results, financial position and cash flow. The company cited temporary closures at operations centers across several regions and said the duration and severity of effects could not be reliably forecast.
  • Response and spending: The company suspended share repurchases temporarily and described cost-reduction measures involving employee and vendor expenses and capital plans. It expected 2020 capital expenditures of $32–$38 million; first-quarter capex was $12.3 million.
  • Goodwill: A COVID-related impairment assessment found no impairment at March 31. However, the Healthcare Analytics reporting unit had $181.2 million of goodwill and limited valuation headroom: management reported approximately 15% excess fair value at the most recent annual test, falling to about 10% under a 50-basis-point increase in the discount rate, all else equal.
  • Customer and operating risks: The top ten clients generated 37.3% of revenue. The filing highlights potential client disruptions, delayed or terminated work, receivable-credit risk, remote-work security and continuity risks, pricing pressure, and dependence on attracting and retaining clients and employees.
  • Contingencies: Indian tax authorities had demanded $16.1 million, net of advance payments, for transfer-pricing and permanent-establishment disputes. The company had paid or provided bank guarantees for $7.9 million and had not accrued a liability, stating it expected its position to be sustained. A separate Indian employee-benefit matter could increase historical contributions, but the amount and timing could not be reliably estimated. Management said pending litigation losses could not be reasonably estimated and did not expect current matters to have a material adverse effect.
  • No formal earnings guidance: The filing does not provide a clear full-year revenue or earnings forecast; management stated that the COVID-19 outlook was too uncertain to forecast reliably.

Important facts for investors to verify

  1. How COVID-19 affected subsequent-quarter revenue, delivery capacity, client demand, collections and margins, particularly given the lack of full-year guidance.
  2. Whether operating cash flow improves after the first-quarter working-capital outflow and how much cash is available for use, considering foreign-held funds and potential taxes on distribution.
  3. The schedule and refinancing or repayment plan for revolver principal, especially the $100.0 million classified as due within twelve months at quarter-end, and the status after the April 20 repayment.
  4. Healthcare Analytics reporting-unit performance and valuation assumptions, given its concentration of goodwill and relatively limited impairment headroom.
  5. Developments in Indian tax disputes and the employee-benefit assessment, as well as the effects of customer concentration and Emerging Business contract losses.