ExlService Holdings, Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017; comparisons are with the corresponding 2016 periods. ExlService provides business process management and analytics services. Amounts below are in U.S. dollars; financial statement amounts are in millions unless noted.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $192.3 | $171.2 | $564.4 | $508.7 |
| Gross profit / margin | $67.5 / 35.1% | $59.4 / 34.7% | $194.0 / 34.4% | $176.5 / 34.7% |
| Operating income / margin | $18.7 / 9.7% | $17.4 / 10.1% | $50.7 / 9.0% | $50.0 / 9.8% |
| Net income / margin | $21.1 / 11.0% | $16.1 / 9.4% | $58.2 / 10.3% | $46.2 / 9.1% |
| Diluted EPS | $0.60 | $0.46 | $1.66 | $1.34 |
| Operating cash flow | Not separately stated for the quarter | $72.2 | $56.0 |
Q3 revenue rose 12.4%; nine-month revenue rose 11.0%. Q3 operating income increased 7.5%, while nine-month operating income increased 1.3%. Cost growth, higher SG&A, and depreciation and amortization weighed on operating margins. Nine-month operating cash flow improved by $16.1 million year over year.
Revenue mix and material changes
- Q3 Analytics revenue grew 29.1% to $53.7 million; nine-month growth was 28.4% to $154.3 million. The company attributed some growth to its 2016 IQR and Datasource acquisitions, while Analytics gross margin declined 5.4 percentage points in Q3 and 3.0 points year to date, partly due to higher employee costs and lower-margin acquired businesses.
- Q3 Insurance revenue rose 12.9% to $59.6 million; Healthcare rose 18.2% to $18.9 million. Nine-month Insurance and Healthcare revenue grew 14.6% and 13.9%, respectively.
- “All Other” revenue, including Consulting and Utilities, declined 14.7% in Q3 and 17.1% year to date, primarily reflecting lower revenue in those businesses. Its gross margin also fell 5.6 percentage points in Q3 and 5.0 points year to date.
- Q3 gross margin improved 0.4 percentage point, but nine-month gross margin declined 0.3 point. Management cited margin expansion in several businesses, offset by weaker Analytics and All Other margins and client-transition costs in Finance and Accounting.
- Q3 SG&A rose 16.8% to $39.1 million; nine-month SG&A rose 12.8% to $114.5 million. Higher employee costs, doubtful-account reserves, and new-center infrastructure costs contributed.
Cash, debt, and liquidity
- At September 30, 2017, cash and cash equivalents were $87.7 million and short-term investments were $161.7 million, for combined cash and short-term investments of $249.4 million, versus $226.6 million at December 31, 2016. The company reported $205.1 million of that combined amount held by foreign subsidiaries and said it intended to indefinitely reinvest foreign earnings.
- Cash and cash equivalents fell $125.5 million over the nine months, primarily as investment purchases and capital spending exceeded operating cash generation. Investing cash outflow was $171.1 million, including $143.7 million net purchases of investments and $26.8 million of property and equipment.
- Long-term borrowings were $45.0 million; the company had a $100 million revolving facility maturing October 24, 2019. It reported compliance with its financial covenants. Cash and cash equivalents plus short-term investments exceeded borrowings by approximately $204.4 million.
- Capital expenditures were $26.8 million in the first nine months. Management expected 2017 capital expenditures of $30–$35 million, subject to economic conditions and other factors.
Management commentary, outlook, risks, and unusual items
- Net income growth substantially reflected lower income tax expense: the effective tax rate was 11.8% in Q3 and 11.0% for nine months, versus 26.0% and 28.6% in 2016. Lower rates included $3.5 million and $7.2 million of excess tax benefits on stock awards, respectively; the nine-month period also benefited from a $3.2 million resolution of an uncertain tax position. These factors make earnings growth less representative of operating growth.
- Nine-month other income declined $3.3 million, partly because 2016 included a $4.1 million reversal of an acquisition earn-out liability. Foreign-exchange gains increased to $7.3 million for nine months from $3.6 million.
- Management identified client concentration, long sales cycles, competition and pricing pressure, hiring and retention, offshore-outsourcing sentiment, technology disruptions, international operations, foreign-exchange exposure, and tax and regulatory changes among the business risks. The top ten clients generated 38.3% of Q3 revenue; no individual client exceeded 10%.
- Indian tax authorities had disputed assessments totaling $16.1 million as of September 30, 2017, primarily involving transfer pricing and permanent establishment matters. The company had paid or provided bank guarantees for $8.4 million, recorded no accrual, and said it considered ultimate liability remote. Additional assessments may arise.
- On October 24, 2017, a subsidiary agreed to acquire substantially all assets of Health Integrated, a care management company; closing was expected in Q1 2018, subject to conditions. Purchase price and financing details are not provided in the filing text supplied.
- The company planned to adopt the new revenue recognition standard on January 1, 2018 using the modified retrospective method. It was assessing the impact, including possible changes to timing of variable-consideration revenue and capitalization of certain contract costs; the ultimate financial effect was not yet clear.
- Management stated that disclosure controls were effective and that there were no material changes in internal control over financial reporting during the quarter. No off-balance-sheet arrangements were reported.
Most important facts for investors to verify
- Whether revenue growth and segment margin trends—especially Analytics and “All Other”—persist, and how much growth reflects acquisitions versus underlying client expansion.
- How much earnings improvement is attributable to recurring operations versus stock-award tax benefits and the tax-position resolution.
- Cash conversion and the allocation of liquidity among investments, capital expenditures, share repurchases, and the announced Health Integrated acquisition.
- Resolution, timing, and potential cash exposure from the Indian tax disputes, including the possibility of further assessments.
- The eventual effect of the 2018 revenue standard and whether client concentration, pricing pressure, or delivery-cost inflation affects margins.