ExlService Holdings, Inc. — Q2 2016 Form 10-Q
Business context and period: ExlService provides Operations Management and Analytics services, primarily to clients in the U.S. and U.K. This unaudited filing covers the quarter and six months ended June 30, 2016, compared with the same 2015 periods. Amounts below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Financial performance
| Metric | Q2 2016 | Q2 2015 | First half 2016 | First half 2015 |
|---|---|---|---|---|
| Revenue | $170.5 (+9.5%) | $155.6 | $337.5 (+12.8%) | $299.1 |
| Gross profit / margin | $58.5 / 34.3% | $55.1 / 35.4% | $117.1 / 34.7% | $105.5 / 35.3% |
| Operating income / margin | $16.2 / 9.5% | $15.2 / 9.8% | $32.7 / 9.7% | $28.7 / 9.6% |
| Net income | $16.4 | $12.1 | $30.2 | $21.6 |
| Diluted EPS | $0.47 | $0.35 | $0.88 | $0.63 |
Q2 revenue growth came from both segments: Operations Management revenue rose 4.7% to $130.9 million and Analytics rose 29.6% to $39.6 million. For the first half, Operations Management grew 4.0% to $258.9 million and Analytics grew 56.4% to $78.6 million; Analytics growth included $11.9 million from the RPM acquisition. Q2 operating income grew more slowly than revenue, and gross margin declined year over year, reflecting cost growth, including employee-related and operating costs.
Cash flow, liquidity and debt
- First-half operating cash flow was $26.9 million, versus $27.2 million in 2015. Management attributed the modest decline primarily to increased working capital, including higher receivables and lower accrued employee costs.
- First-half investing cash use was $106.0 million, including $91.1 million net purchases of short-term investments and $14.9 million of capital expenditures. Financing used $30.7 million, including $25.0 million of debt repayments and $9.0 million of share repurchases.
- Cash and cash equivalents were $93.1 million at June 30, down from $205.3 million at year-end. Cash, cash equivalents and short-term investments totaled $200.7 million, compared with $219.0 million at year-end; $147.3 million of the June total was held by foreign subsidiaries, which the company expects to reinvest indefinitely overseas.
- Debt was $45.0 million, down from $70.0 million at December 31, 2015. The company had a $100 million revolving facility maturing in October 2019 and reported compliance with its covenants. The effective borrowing rate for Q2 2016 was approximately 1.95%.
- Current assets were $343.8 million and current liabilities $100.5 million at June 30. Total assets were $646.9 million and total equity was $497.0 million.
Changes, outlook and risks
- Earnings quality: Other income was $5.8 million in Q2, versus $1.3 million a year earlier. It included a $3.8 million gain from reducing the estimated RPM acquisition earn-out liability to zero. First-half other income included a $4.1 million earn-out gain and $3.0 million of unrealized investment gains. These items materially contributed to net income growth.
- Management outlook: The company expected 2016 capital expenditures of $25–$30 million; it provided no specific revenue or earnings guidance in the supplied filing text. Management anticipated Analytics growth through expanded offerings and clients, organically and through acquisitions.
- Operating and market risks: The top ten clients generated 40.4% of first-half revenue, though no single client exceeded 10%. The company cited client concentration, competition and pricing pressure, hiring and retention, technology disruption, data security, acquisition integration, and international operations as risks. Brexit-related currency volatility could affect results; U.K. clients contributed 16.7% of first-half revenue, with some contract protections against exchange-rate movements.
- Tax contingency: Indian tax authorities disputed transfer-pricing and permanent-establishment matters, with aggregate assessments of $20.4 million at June 30. The company had paid or provided guarantees for $14.2 million, including $12.2 million in deposits and $2.0 million in restricted cash. Management, relying on tax advisers, considered the likelihood of liability remote and had not accrued an amount; additional assessments remain possible.
- Subsequent event: On July 1, 2016, the company acquired U.K.-based Liss Systems Limited for £5.5 million, including £4.3 million cash and £1.2 million in restricted stock.
- Management reported effective disclosure controls as of June 30, 2016, and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of reported earnings growth reflects operating performance versus the RPM earn-out reversal, investment fair-value gains and foreign-exchange effects.
- Whether revenue growth, particularly in Analytics, continues and whether gross-margin pressure from wage, staffing and operating costs persists.
- Receivables, working-capital trends and the allocation and availability of cash held by foreign subsidiaries.
- Progress and potential outcomes in the Indian tax disputes, including possible additional assessments and required deposits or guarantees.
- Integration, performance and financing implications of the Liss acquisition, alongside planned 2016 capital expenditures and ongoing currency exposure.