ExlService Holdings, Inc. — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012; unaudited results compared with Q1 2011. Amounts below are in U.S. dollars; financial-statement figures are converted from thousands to millions where appropriate.
Business context
ExlService provides outsourcing and transformation services, primarily to clients in the United States and United Kingdom. Outsourcing includes front-, middle- and back-office processing; transformation offerings include decision analytics, finance transformation, and operations and process excellence. The May 2011 OPI and October 2011 Trumbull acquisitions contributed to the period’s growth.
Key financial metrics
| Metric | Q1 2012 | Q1 2011 | Change / context |
|---|---|---|---|
| Revenue | $104.6m | $72.9m | Up 43.5% |
| Gross profit / margin | $37.9m / 36.3% | $28.7m / 39.3% | Profit up 32.2%; margin down 3.0 percentage points |
| Operating income / margin | $10.4m / 10.0% | $7.5m / 10.3% | Income up 38.9%; margin down 0.3 percentage points |
| Net income / margin | $8.9m / 8.5% | $8.4m / 11.5% | Income up 6.6%; margin down 3.0 percentage points |
| Diluted EPS | $0.27 | $0.27 | Unchanged |
| Operating cash flow | $4.4m | $7.8m | Down; working-capital movements were the main drag |
| Capital expenditures | $9.3m | $7.2m | Operating cash flow less capex was approximately negative $4.9m, versus positive $0.6m |
Liquidity and debt: Cash and cash equivalents were $82.3m and short-term investments were $7.3m at March 31, for combined cash and investments of $89.5m. Current assets were $170.6m and current liabilities $55.7m. Capital lease obligations totaled $5.9m; there were no borrowings under the $50m revolving credit facility. Total liabilities were $77.9m, down from $98.9m at December 31, 2011.
Other metrics: Total assets were $383.4m. Cash and restricted cash totaled $86.7m. Days sales outstanding were 50, versus 49 at year-end. Comprehensive income was $21.6m, including $12.7m of other comprehensive income, mainly from hedge and currency-translation gains.
Material changes and management commentary
- Outsourcing revenue increased to $89.7m from $56.8m. Management attributed the increase primarily to $26.8m of revenue from the OPI and Trumbull acquisitions and $8.4m of net volume growth from existing and new clients, partly offset by $2.3m of foreign-exchange-related revenue decline.
- Transformation revenue declined to $14.9m from $16.1m, mainly because of fewer project-based finance-transformation engagements.
- Cost of revenue rose faster than revenue, to 63.7% of revenue from 60.7%; management cited acquisition-related costs, staffing and facility investment. Gross margin consequently fell. SG&A declined as a share of revenue, from 22.4% to 20.2%.
- The effective tax rate rose to 25.3% from 11.8%. Management attributed the increase principally to the expiration of Indian tax holidays beginning April 2011 and a $2.0m deferred-tax valuation-allowance release in Q1 2011. Management cautioned that taxes may remain higher.
- The company expects revenue to grow through service and client-base expansion, organically and through acquisitions. It expects $15m–$20m of capital expenditures during the remainder of 2012, mainly for facilities, growth requirements and internal technology. No specific earnings or revenue guidance range is provided.
Risks, contingencies and unusual items
- Revenue remains concentrated: the three largest clients contributed 26.7% of Q1 2012 revenue. Travelers alone represented 10.5%; it may terminate its services agreement or individual work orders on 60 days’ notice.
- Management highlights pricing pressure from transaction-based models and multi-vendor arrangements, which may pressure margins; transformation projects are shorter-term and may fluctuate.
- The company reported Indian tax-authority disputes involving assessment demands totaling $20.1m, including interest. It had deposited $13.3m and provided $2.6m in bank guarantees. Management considers the probability of loss remote and recorded no accrual; similar assessments for subsequent years may arise.
- Foreign-exchange exposure includes the Indian rupee and U.K. pound, among other currencies. The company uses forward contracts; approximately $4.1m of net derivative losses in accumulated other comprehensive income could be reclassified to earnings within 12 months, based on March 31 exchange rates.
- Operating leases, capital leases, purchase obligations and estimated gratuity payments totaled $50.2m of contractual cash obligations. The filing excludes $5.5m of uncertain tax positions because payment amount and timing cannot be reliably determined.
- One Philippine tax holiday was due to expire in mid-2012, with a possible extension; management notes extensions could be denied. Management also identifies acquisition integration, hiring and retention, offshore-outsourcing sentiment, competition, currency changes, and economic or political conditions as risks.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether acquisition-related growth translates into sustained organic growth, particularly given the decline in transformation revenue.
- Whether gross and net margins stabilize as acquisition costs, staffing, facilities investment and higher taxes affect results.
- Whether operating cash flow improves after the substantial working-capital outflow and elevated capital spending.
- Client concentration and the status and termination provisions of the Travelers agreement.
- Progress and potential financial exposure in Indian tax disputes, and the outlook for Indian and Philippine tax incentives.
- Whether the stated 2012 capital-expenditure plan and expected growth remain appropriate as client demand and operating-center expansion evolve.