ExlService Holdings, Inc. — Q2 2017 Form 10-Q
Business and period: Unaudited results for the three and six months ended June 30, 2017, compared with the corresponding 2016 periods. ExlService provides business process management and analytics services, principally to clients in the U.S. and U.K.
Financial performance
Amounts are in millions of dollars except per-share data and percentages.
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Revenue | $189.1 | $170.5 | $372.1 | $337.5 |
| Gross profit | $63.6 | $58.5 | $126.5 | $117.1 |
| Gross margin | 33.6% | 34.3% | 34.0% | 34.7% |
| Operating income | $16.1 | $16.2 | $32.0 | $32.7 |
| Operating margin | 8.5% | 9.5% | 8.6% | 9.7% |
| Net income | $20.4 | $16.4 | $37.2 | $30.2 |
| Diluted EPS | $0.58 | $0.47 | $1.06 | $0.88 |
| Operating cash flow | Not provided quarterly | Not provided quarterly | $46.9 | $26.9 |
- Q2 revenue rose 10.9%; six-month revenue increased 10.2%. Analytics revenue grew 30.2% in Q2 and 28.0% year to date, including contributions from 2016 acquisitions. Insurance also grew strongly, while “All Other” revenue fell 17.5% in Q2 and 18.2% year to date, primarily reflecting lower Consulting and Utilities revenue.
- Despite revenue growth, operating income was slightly lower in Q2 and down 2.0% for the half. Gross margin declined 70 basis points in both comparisons; management cited higher employee costs, acquisition-related costs, and weaker performance in certain segments.
- Net income increased, but reported tax expense was unusually low: the effective tax rate was 3.9% in Q2 and 10.5% for the half, versus 30.0% and 29.9%. The 2017 results included excess stock-award tax benefits and a $3.2 million benefit from resolving an uncertain tax position. Foreign-exchange gains also increased. Lower 2016 other income included an earn-out liability reversal, making year-over-year comparisons less straightforward.
- Six-month operating cash flow was $46.9 million. Investing cash outflow was $150.4 million, largely reflecting purchases of short-term investments; capital expenditures were $20.4 million. Financing cash outflow was $21.6 million, including $23.3 million of treasury-stock purchases. Cash and equivalents declined to $89.4 million from $213.2 million at year-end, while cash, equivalents, and short-term investments together were $237.3 million.
Balance sheet, liquidity, and outlook
- At June 30, cash and equivalents were $89.4 million and short-term investments were $147.9 million. Total current assets were $398.6 million and current liabilities $116.0 million.
- Borrowings totaled $45.0 million, including $10.0 million classified as short-term. The $100 million revolving facility matures in October 2019; the company reported compliance with its financial covenants. It also had $0.5 million in capital lease obligations.
- Management expects 2017 capital expenditures of $30–$35 million, principally for facilities and technology. It expects to fund operations, capital expenditures, working capital, and smaller acquisitions from operating cash flow; significant acquisition-led growth could require additional financing.
- No specific revenue or earnings guidance is provided in the filing. Management expects to reinvest foreign-subsidiary earnings abroad and does not currently intend to repatriate those funds.
Risks, contingencies, and notable items
- Indian tax disputes: authorities had demanded an aggregate $17.1 million relating primarily to transfer pricing and permanent-establishment issues. The company had paid or provided bank guarantees for $8.5 million, recorded no provision, and said its advisors considered ultimate liability remote; additional assessments remain possible.
- Customer concentration remains relevant: the top ten clients generated 39.1% of Q2 revenue and 39.0% of first-half revenue. No single client exceeded 10%.
- Management identifies risks including competition and pricing pressure, client retention, wage inflation and employee availability, foreign-currency movements, international operations, data security, and changes to government incentives. Alternative pricing and multi-vendor sourcing may pressure revenue or margins.
- The company is evaluating the forthcoming revenue-recognition standard, which it expects may change the timing of recognition for certain variable consideration and contract costs. Adoption was expected in 2018.
- Share repurchases totaled approximately $20.3 million in the first half. The board authorized a repurchase program of up to $100 million over 2017–2019.
Investor verification points
- Assess how much reported earnings growth depended on unusually favorable tax items and foreign-exchange gains, and compare underlying operating trends.
- Track recovery or further deterioration in “All Other” revenue and segment margins, particularly Analytics and Consulting/Utilities performance.
- Reconcile the sharp fall in cash and equivalents with investment purchases, and monitor liquidity, capital spending, and buybacks.
- Review developments in the Indian tax disputes, including potential additional assessments and required deposits or guarantees.
- Monitor client concentration, wage and infrastructure cost growth, and the impact of contract pricing and the new revenue-recognition standard.